Standard & Poor’s Hits Chicago Water, Sewer Bonds

CHICAGO -- Standard & Poor's hit Chicago's water and sewer revenue bonds with a three-notch downgrade Monday citing liquidity pressures created by Moody's Investors Service's recent Chicago downgrades.

Standard & Poor's dropped its rating on senior-lien water and wastewater bonds to A from AA, lowered its rating on the city's subordinate-lien water and wastewater bonds to A-minus from AA-minus, and placed the ratings on CreditWatch with developing implications.

The agency placed second-lien wastewater and water bonds that are also secured with letters of credit on CreditWatch negative.

"The downgrade is due to uncertainty as to whether the city will be able to reduce or eliminate potential claims on the liquidity of its water and sewer funds caused by rating triggers, which are considered either events of default or termination events pursuant to various liquidity, direct purchase, and swap agreements," said Standard & Poor's analyst Scott Garrigan.

"Although the city has represented that it is working with the counterparties to execute forbearance agreements and avoid payment accelerations, the need to execute these explicit written changes to avoid potential liquidity claims is a characteristic that, in our view, is not consistent with a higher rating level," Garrigan added.

The city has $38 million in outstanding senior-lien water revenue bonds, $2.3 billion in outstanding second-lien water revenue bonds, $35 million of senior-lien sewer bonds, and $1.5 billion in outstanding second-lien sewer revenue bonds.

Moody's, while downgrading Chicago general obligation bonds to junk May 12 also lowered the city's water and wastewater bonds lowered two notches to ratings between Baa3 to Baa1

Banks could demand $123 million in termination payments on swaps tied to its second-lien wastewater and water bonds because of the Moody's downgrade. A termination event was also triggered on the three direct purchase agreements supporting $332 million of 2008 wastewater bonds, which allows the banks to terminate the agreement.

The CreditWatch with developing implications reflects the agency's opinion that the rating could be raised, lowered, or affirmed, depending on the terms of any forbearance agreements struck by the city and its banks and is expected to be resolved within 60 days.

Standard & Poor's warned that even the negotiation of new terms doesn't let the city off the hook from further deterioration as a downgrade could still result if rating trigger thresholds are no more than two notches below the lowest rating level from the termination or default trigger.

"The reason for this is that when a two-notch downgrade would cause additional or accelerated claims on liquidity, our liquidity analysis will include these potential obligations, in this case accelerated bond payments and swap termination payments," analysts said. "Given this requirement, the rating would likely have been lowered by at least one category if the city did not indicate it is negotiating forbearance agreements."

If the city sufficiently lowers the risk the rating could be affirmed and if it can win relief that eliminates any contingent liquidity risk, the rating could be raised.

The rating agency said it's not received any fresh financial information on the health of the water and wastewater systems since its last review was conducted last August.

"However, given the expansive customer base and 15% rate increases that are affective for the 2015 fiscal year, we do not have any reason to believe that the underlying economic and financial profile would be inconsistent with the current rating level. If information comes to light that, in our view, contradicts this assessment, we could lower the rating," analysts wrote.

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