Chicago's Position Bolstered by Deal Overhaul

CHICAGO — Chicago's revamp of its $800 million floating-to-fixed debt restructuring helps its position as it heads into the market this week with battered credit ratings, say several buyside participants.

"We believe the marketability of the financing will be significantly enhanced by the consolidation of the original four issues into one large deal, led by one of the major banks," said Jim Grabovac and Dawn Mangerson, managing directors and senior portfolio managers at McDonnell Investment Management LLC. "And if the city can successfully place the financing it should help stabilize the credit over the near term."

Chicago pulled back a smaller version of the deal May 19 that had two smaller firms at the helm as it hurried to re-think its strategy following its May 12 Moody's Investors Service downgrade to a junk-level rating of Ba1.

The hit from Moody's to its general obligation bond rating, as well as a simultaneous downgrade of its water and sewer bonds, put Chicago on the brink of a liquidity crisis because the ratings actions pulled triggers and created default events on swaps, credit lines, and credit facilities for $2.2 billion of bank-supported debt.

The upcoming sale converting GO floating-rate paper to a fixed rate - and a conversion of $100 million of sales tax bonds next month -- is designed to ease some of the liquidity risks by allowing Chicago to shed letters of credit it needed for the variable-rate debt.

The city on Wednesday will offer a total of $645 of fixed-rate bonds to convert the $800 million, with the remaining funds needed to redeem the floating-rate paper coming from its short term borrowing program.

The city will offer $172 million from its $200 million 2002 issue, $169 million from its $180 million 2003 issue, $162 million from its $222 million 2005 issue, and $143 million from its $200 million 2007 issue.

All will include a mix of serial and term bonds with the respective final maturities in 2037, 2034, 2040, and 2042, according to an investor presentation posted late Friday with the deal's offering statements. The city will make a total of $200 million in swap termination payments due to negative valuations on derivatives tied to the bonds.

Delaying the sale gave the market time to digest the news and allowed the city to quickly consolidate four separate transactions down to one.

Chicago gave the books to Bank of America Merrill Lynch, published new offering statements early Thursday to price Wednesday. It's trying to stay on schedule to close on already published redemption dates of May 29 and June 8 for the floating-rate paper.

The city still faces steep yield penalties but market participants say the revamp was wise and could work in its favor.

"It was a good tactical decision to delay. It's very difficult coming into the market the week after those kind of downgrades," said Brian Battle, director of trading at Performance Trust Capital Partners. "The decision to upsize was smart and to bring in more horsepower was a good idea."

With a series of transactions, the city risks the first one "poisoning the well" on the subsequent ones based on the pricing, because potential buyers know there is more debt coming.

"The buyers then have more leverage" with prices set at what can clear the market, Battle said. Potential investors also now will have in mind the "bigger balance sheet" of BofA/ML and its ability to takedown bonds as they submit orders.

Spreads on city general obligation bonds shot up after the downgrade and have fluctuated with 25 basis point bounces seen daily. Its spreads to the Municipal Market Data top-rated benchmark have hovered between 250 and 300 basis, Battle said.

That's up from 200 to 250 before the downgrade. Wednesday's primary market pricing should more firmly set city prices and Battle said there's a chance city GOs could rally after.

"There's a payoff for investors who can tolerate headline and political risks," he said.

The city and its finance team conducted investor calls Friday as part of the rush to update the market on the sale, its efforts to stave off a liquidity crisis, and to tackle its pension funding and budget ills.

Citi, Ramirez & Co. Inc., and Siebert Brandford Shank & Co. will be co-senior managers. Another eight firms round out the syndicate on the transaction. Columbia Capital Management Inc. is advising the city. Ramirez and Siebert were to have been the senior managers on the first two tranches of borrowing before the deal was restructured.

In disclosure tied to the offering, the city reported that it's struck forbearance agreements with banks that support its GO bonds until after their planned closing dates, and more significantly, on its short-term credit lines.

The city also reported it has a new line and an expanded one in place. The city can use the new line to supplement the bond proceeds in converting the 2005 bonds.

Moody's dropped the city due to worries over the impact of a recent Illinois Supreme Court ruling voiding state pension reforms on Chicago's pension reform efforts.

Fitch Ratings and Standard & Poor's then downgraded Chicago within investment grade territory, to BBB-plus and A-minus, respectively, due to the liquidity risks posed by the Moody's downgrades.

Kroll Bond Rating Agency gave the city some breathing room to reach forbearance agreements. "Based upon resolution of short-term liquidity issues through forbearance agreements, KBRA has affirmed the A-minus rating and stable outlook," analysts wrote in a report Thursday.

The city also has entered into forbearance agreements on interest-rate swaps on which the Moody's downgrade triggered terminations that extend through the planned conversion dates.

On its short term borrowing program, banks have entered forbearance agreements until Sept. 30 and the city said it is negotiating on extensions. The city had capacity to borrow up to $700 million and one bank has now increased its line by $200 million and it has a new line for $200 million.

The offering statements did not provide an update on sewer and water debt triggers that resulted from the Moody's downgrade and several investors who spoke with the city on Friday said the city declined to provide an update. The city's water system faces swap termination risks of $110 million while the sewer system could face principal repayment of its direct bank loans totaling $332 million within a three to six month period as well as swap termination costs of $25 million, if demanded by banks.

In the investor roadshow, outgoing chief financial officer Lois Scott introduced incoming CFO Carole Brown.

Scott sought to highlight pension reforms approved for the municipal and laborers funds and corporation counsel Stephen Patton outlined the city's legal arguments that differ from the state's arguments recently rejected by the Illinois Supreme Court.

The city's contribution for its municipal and laborers' funds will rise by $95 million next year.

The city will seek state relief from a $550 million spike for police and fire pension funds under a prior state mandate to move to a 90% funded ratio by 2040.

The reforms to the municipal and laborers' funds put the city on a path to a 90% funded ratio in 2055. The city's four funds are collectively funded at a 36.8 % ratio.

Scott also sought to highlight Emanuel's recent announcement on debt management changes that included the elimination of floating-rate GOs and the termination of swaps. The plans also include phasing out scoop and toss debt restructurings by 2019 and trimming the use of debt to cover some operating costs like legal judgments.

"For too long Chicago lived beyond its means and engaged in financial maneuvers to mask the true scope of our problems and financial challenges," Scott said. "To be honest we continued this practice but now is the time for it end."

Aaron Weitzman contributed to this story.

For reprint and licensing requests for this article, click here.
Illinois
MORE FROM BOND BUYER