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Chicago Readies Billion Dollar GO Deal

CHICAGO – Chicago is conducting a full court press with investors this week to promote its budget and pension funding gains ahead of a $1.16 billion general obligation sale.

Even if investors downplay the city's own looming fiscal pressures, its spread penalties next week could suffer from fallout from the Chicago Public Schools' fiscal woes and the state government's political dysfunction, market participants said.

In the year since Chicago last sold debt under its GO credit, Mayor Rahm Emanuel's administration completed work on near-term pension funding fixes, dealt with the smallest budget deficit of his six years in office, and got good news from three rating agencies.

Fitch Ratings, Kroll Bond Rating Agency and S&P Global Ratings shifted their outlook to stable from negative on the city's triple–B level ratings.

"Notably, the city has identified and dedicated permanent revenue streams to address its pension costs," Chicago's chief financial officer, Carole Brown, told investors in a recorded presentation.

Those gains are set against a backdrop of pension funding strains that loom in a few years when actuarially based payments kick in to stabilize a system saddled with $33.8 billion of net pension liabilities. The city's overhaul of two of its pension funds is still not final; Gov. Bruce Rauner has threatened a veto of the legislation to overhaul the funds.

Other pressures also lie ahead as the city weans itself off the use of debt for budget relief through scoop-and-toss debt restructuring and borrowing to pay for settlements and judgments. Moody's Investors Service still rates Chicago in junk territory.

The city disclosed on Tuesday that Emanuel formally requested that the rating agency remove the city's ratings.

In a stinging letter dated Dec. 8 to Moody's president and chief executive officer Raymond W. McDaniel Jr., Emanuel accused the rating agency of failing to recognize the city's strides on factors identified by Moody's as needed to win an upgrade. "With each rating action or market comment, Moody's instead introduces new and sometimes unrelated factors to justify its negative view of the city's credit," Emanuel wrote. "All the while, measurable progress by the city to confront the fiscal challenges do nothing to impact our rating our outlook."

"It has become increasingly clear that Moody's rating methodology and agenda are far from objective and independent…your current rating does not accurately reflect the city's credit or our ability to pay debt service when due," the letter continued. If Moody's does not grant the request, Emanuel said it should be made clear that any opinions from Moody's are based solely on publicly available information.

Moody's spokesman David Jacobson would say only in response to a request for comment that "Moody's has a process for handling requests from issuers to withdraw their ratings and follows that process when such requests are made" and it does not comment on potential future rating actions.

"The city has made progress and should be applauded for making tough, politically unpopular decisions. That being said, these decisions and the new revenues merely moved out the horizon of credit risk," said Tom Schuette, co-head of investment research and strategy at Gurtin Municipal Bond Management.

"It will take tremendous political discipline to continue to devote the resources needed to improve pension funding levels," he said. "Especially considering that despite doubling their pension contributions over the past two years, they still fall well short of contributing what is necessary to just stop the bleeding."

The firm does not purchase Chicago general obligation bonds.

The issue is expected to sell Jan. 18 or 19 and will offer a mix of new money and refunding bonds in a tax-exempt $887.5 million series and a taxable $275 million series. The latter is tentatively structured as a term bond in 2028 while the tax-exempt series matures serially between 2028 and 2038.

The city is hosting three investor presentations this week: Wednesday in Chicago, Thursday in Boston, and Friday in New York City with additional availability for one-on-one investor meetings.

The city has not finalized redemption provisions, couponing, and serial and term structures.

Goldman Sachs is senior manager.

Proceeds will fund the city's 2016 and 2017 capital program and portions of the city's aldermanic project menu; $225 million will cover settlements and judgments, $440 million will be used to restructure some debt in what's been promised by Emanuel as the final use of the city's practice of pushing off debt repayment, as well as refunding for savings, and capitalized interest. Emanuel has also pledged to end the use of debt to cover judgments and settlements by 2019.

The city had previously said just $100 million of the upcoming deal would go to cover settlements and judgments and $335 million for debt restructuring. The much-maligned practice of scoop-and-toss began a decade ago as former Mayor Richard Daley's administration sought to smooth out rising debt service, and continued under Emanuel. The city's January 2016 deal included about $220 million of scoop-and-toss for 2015 budget relief.

The city highlights its improving economic base, management measures, and fiscal policies that have improved its economy and paved the way for tax increases to address "long term liabilities, reduce the structural budget deficit and invest in strategic priorities," Brown said. The city has increased its corporate fund revenues by $1 billion since 2011.

The city is stressing its improved liquidity and reserve policies, its shedding of floating-rate and swap exposure in the GO credit, and other debt policy changes aimed at stabilizing a fiscal foundation that was rocked in 2015 when Moody's dropped its rating to junk.

The downgrade triggered bank credit and swap termination events that could have forced the city to come up with $2.2 billion. The city resolved the issues but it was costly as it pushed $700 million onto its debt tab to deal with defaulted credit lines and paid $395 million to cancel GO and revenue bond related swaps.

The city's liquidity status benefits from $620 million in long-term reserves.

The city also has access to a $510 million credit line with three banks that currently has an outstanding balance of $127 million.

Chicago pared back its structural deficit in an overall $8.2 billion budget to $137 million heading into 2017, the lowest since Emanuel took office in 2011, and has made modest deposits in reserves that the Daley administration tapped.

On the horizon, strains loom. Revenue streams are in place in the short term to match rising payments for the city's four pension funds but in 2021 the city will need to identify new revenue because a big leap is made to actuarially based payments to keep the funds on a course to reach a 90% funded ratio in 2055.

Also, budget gaps are projected to grow. The city projects a deficit of $324 million in 2019 based on modest growth, $144 million on positive growth, and $780 million based on a negative scenario.

Chicago's fiscal gains over the last year may not help narrow the city's punishing spreads given current trading levels, but absent those strides the city would face even steeper penalties, said Brian Battle, director of trading at Performance Trust Capital Partners.

"You definitely have to acknowledge that the mayor did something unpalatable [in raising taxes] but the problems are big and long term…the stuff that plagues the city is still in place," Battle said. "The state is completely disorganized and the city is dependent on a lot that happens in Springfield."

Schuette also sees a possible contagion effect.

"You have a very uncertain future on the state's budget and what effects that could have on Chicago, what will happen to Chicago Public Schools, and if local budget solutions for CPS will sap the political will or public appetite for additional future tax increases," he said.

Chicago GOs don't trade often but recent spreads from the triple-A benchmark have landed between 250 and 300 basis points. The city's 10-year landed at a 253 basis point spread to the Municipal Market Data's top benchmark on the $500 million refunding last year. The city did reap a spread benefit from its passage of a big property tax increase in the January 2016 pricing, when its spreads improved over a sale the previous summer.

The city did not offer a 10-year maturity on its GO sale in July 2015 but its nine-year maturity landed 290 basis points over MMD's triple-A benchmark. In a May 2015 GO sale, Chicago saw spreads of 293 basis points on its 10-year.

Kroll shifted its outlook on Chicago's BBB-plus rating to stable from negative late last month, following similar moves by Fitch and S&P after the City Council's October passage of the water/sewer tax to save its municipal fund.

S&P affirmed the city's BBB-plus rating in late December and Fitch affirmed its BBB-minus last week.

Moody's, which rates Chicago Ba1 with a negative outlook, has not been asked to rate recent city deals. The city has $9 billion of GO debt.

"Aside from its pension funding issues, Chicago's financial profile has markedly improved in recent years," Fitch analysts wrote, "although full structural balance remains a challenge, and the city's financial cushion provides solid capacity to address cyclical downturns."

S&P said its stable outlook reflects a belief that the city is gradually moving in the right direction toward stabilizing its budget and its pension plan contributions.

Mesirow Financial Inc. and Estrada Hinojosa are co-senior managers and another seven firms round out the syndicate.

PFM Financial Advisors LLC and Public Alternative Advisors LLC are advising the city.

Martin J. Luby LLC is municipal advisor.

Schiff Hardin LLP and Sanchez Daniels & Hoffman LLP are bond counsel.

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