After reneging on debt pledge, Chicago suburb seeks a fresh credit start
CHICAGO – With the ink dry on a court-approved restructuring of $190 million of hotel and conference debt, a Chicago suburb wants to rebuild its relationship with rating analysts and investors.
The village’s appropriation pledge was attached to a portion of the bonds sold by the Lombard Public Facilities Corp. for the project. Lombard lost its investment grade rating after reneging on the pledge.
“It was a reminder to the rating agency and the market every six months when there was a request to appropriate ... that the village was not making the appropriation,” Village Manager Scott Niehaus said after a bankruptcy court hearing during which the plan was confirmed.
A bond exchange laid out in the LPFC’s Chapter 11 reorganization plan for $140 million of new 50-year, tax-exempt debt took place last week. The village's appropriation pledge is not attached.
The exchange allowed for a March 15 effective date for the confirmation plan approved by U.S. Bankruptcy Court Judge Jacqueline Cox during a hearing in Chicago earlier this month.
The bankruptcy court’s approval was contingent on the execution of the bond exchange through the Wisconsin-based Public Finance Authority. The restructuring calls for recovery rates of 77%, 76% and 86% on the A1-, A2- and B series, respectively, with a subordinated $29 million series taking a near total loss.
Lombard established the corporation to issue the bonds and manage plans for the Westin Lombard Yorktown Center with village support through a tax rebate agreement and its appropriation pledge.
After years of failed negotiations, village and corporation officials struck a deal with key bondholders and the insurer on a portion of the bonds and sought the bankruptcy’s court’s blessing in the Chapter 11 filing last July.
As part of the reorganization, the village board approved a restructuring agreement that provides $3 million for facility improvements and up to a total of $3.7 million in tax-increment financing support in the coming years for site infrastructure improvements.
The village will also continue to contribute revenue from a special 1% so-called Places for Eating Tax enacted last year through 2021 and a tax rebate of about $1 million remains in place.
The village sees big benefits for that assistance. It’s no longer obligated to repay the bonds and the restructuring contains various legal releases for the village, significantly reducing its legal liability.
The restructuring allocates funds to upgrade the facility and puts in place a capital structure that better matches debt to prospective revenues. That aids a development that resulted in 130,000 overnight stays in 2016 and translated into $17.4 million of visitor spending in the area that has seen multiple development projects spurred by the hotel, village officials said.
The village is also hoping it can now get back on the path to investment grade.
S&P Global Ratings in 2012 dropped the village six notches to BBB from AA for failing to make up a debt service shortfall on a portion of the bonds instead allowing for bond reserves to be tapped.
It dropped Lombard to speculative-grade B in February 2014, when the village reneged on its appropriation pledge causing a payment default.
Village officials acknowledge that it will be a long road back.
“One of the strategic goals of the village board is to return to investment grade and they want us to have sound, conservative fiscal policies that would put us on that road,” but there’s no specific timeline, Niehaus said in a joint interview with finance director Tim Sexton.
The village met with S&P last week to update analysts on the restructuring and current status of village finances. Village officials hoped to earn some points from S&P for contributing to the restructuring. “The village participated, it didn’t just walk away,” Niehaus said.
Debt policies and management issues were discussed, such as putting in place a deeper review or standards before a project receives village support, and Sexton said the administration and board might look at measures that could “strengthen” the governance ranking in its credit profile.
The village west of Chicago has just a few million dollars in debt and no immediate plans to access the market, but after relying on pay-as-you-go capital spending for six years is discussing with its financial advisor Speer Financial Inc. re-establishing its credit in the market. That could involve a general obligation issue that could also have a water revenue backing.
The board that endorsed the hotel project believed demand existed, that it would spur economic development, and was worth the risk to the village. The facility has a 500-room hotel, two restaurants, 39,000 square feet of meeting and convention space, a 25-meter indoor swimming pool and fitness center, and a 675-car, four-story parking deck.
The hotel opened in 2007, just in time for a recession, and never generated enough revenue to meet debt service.
Lombard’s finances remain sound with a total available fund balance that equals nearly 50% of fiscal 2016 general fund expenses and total cash and investments of more than $26 million, more than 55% of total governmental fund expenses. Fiscal 2017 revenues are expected to exceed spending by nearly $1 million, even after a $300,000 legal expense for the restructuring.
S&P lead Lombard analyst Eric Harper confirmed the discussion with Lombard and also cautioned that even with the restructuring completed, “it takes a fairly significant amount of time” to see any upward ratings action after defaulting on an appropriation obligation.
“We will look at the village’s financials, the economy, and the debt and the focus is on management,” Harper said. “From our view on the credit, we would need to see improvement in the management conditions” and assess the risks of future non-appropriation.
The long road back is evidenced by two other Midwest credits.
S&P in March 2017 raised Vadnais Heights, Minn., three notches to BB from B, still two notches below investment grade, in recognition of the city’s “continued commitment to meet its debt obligations.” The city voted in 2012 against appropriating funds needed to cover debt service on bonds sold in 2010 to finance a sports facility.
“We continue to view the city's willingness to support its debt as uncertain,” S&P said. “Vadnais Heights does not have a debt management policy, and it has not created any new policies or amended any in response to the non-appropriation event.”
Moberly, Mo., was raised two notches by S&P to BB-minus from B in 2016. It lost its investment grade rating for failing to appropriate needed funds in 2012 to cover debt service on 2010 bonds sold to help finance an artificial sweetener plant.
“The upgrade reflects our opinion that the city has taken steps to establish a better framework for avoiding future events of non-appropriation” with the adoption of debt and due diligence policies, S&P said. “It also reflects the city's continued commitment to its existing appropriation debt.”
For investors, the Lombard project is a reminder that the essential nature of a project is a primary factor in assessing whether a municipality might live up to its obligations, not just whether the municipality has the ability to pay, as Lombard did.
“Over and over again that lesson needs to be taught and heeded,” said Richard Ciccarone, president at Merritt Research Services LLC.
For governments, a deep examination of the “risk-reward” is needed, he said. “They have to realize that if it doesn’t work they will suffer the consequences and the price may last well beyond” the resolution of the problem such as in the loss of one’s investment-grade status."
The Chapter 11 case was filed after years of defaults and failed negotiations finally led to a “consensual restructuring.” The corporation and ACA Financial Guaranty Corp. had been in discussions since late 2013 on a restructuring. Village officials said it was then that a new board was in place that was more willing to put some city funds on the line to resolve the issue.
The reorganization received overwhelming to unanimous approval in a balloting process. Major bondholders include Nuveen Asset Management, Oppenheimer Rochester High Yield Municipal Fund, and ACA Financial Guaranty, insurer on a portion of the bonds and a holder and controlling party based on the original bond indenture.
The filing survived a bondholder-led challenge to its eligibility for Chapter 11. Cox rejected arguments that the project and corporation were too closely linked to its Lombard – its municipal sponsor – to qualify for Chapter 11. Lord Abbett appealed but dropped the challenge after a lead bondholder purchased its estimated $8.5 million in holdings.
The original deal totaled nearly $200 million, with $64 million of A-1 bonds that will see a 77% recovery rate, $54 million of insured A-2 bonds with a recovery rate of 76%. Holders received a commutation offer to opt out from ACA. The B series for $43 million received an 86% recovery rate.
The $29 million C series was canceled and the former asset manager, Mid-America Hotel Partners LLC, which is a major holder, agreed to accept $35,000 per year over 15 years and a $200,000 payment to cover attorney fees.
Chapter 9 municipal bankruptcy was not an option. The state lacks such a statute and the corporation would not meet the legal characteristics of a municipality that could take advantage of Chapter 9.
The PFA was asked to serve as the conduit because the LPFC can’t issue 50-year bonds under state statute. The authority said the exchange for new 50-year, tax-exempt bonds was completed as planned March 15. No agent or banker was used and there were no offering documents.
Greenberg Traurig LLP was tax counsel and Taft Stettinius & Hollister LLP was bond counsel.