CHICAGO — In a deal brokered by federal authorities, Chicago Mayor Richard Daley and officials from American Airlines and United Airlines announced an agreement Monday that allows the city to begin work on $1.17 billion worth of a remaining $3.36 billion of expansion projects at O’Hare International Airport.

Under the agreement, Chicago can proceed with construction of one new runway and some land improvements. The city agreed to put off other projects that are part of the completion phase of the O’Hare Modernization Program, and the airlines will drop their lawsuit challenging the city’s authority to proceed with projects without their go-ahead.

Under the pact, the airlines will provide nearly $398 million in funding by supporting general airport revenue bonds, another $365 million would come from passenger facility charges, and $517 million would come from Federal Aviation Administration grants. Federal authorities increased their level of grant support by $155 million to help clinch the deal.

The dispute over whether Chicago could proceed with the projects without airline approval prompted the carriers to file a lawsuit against the city on Jan. 18. American and United — which together handle about 80% of O’Hare’s passenger traffic — sought to block the city from starting construction projects this spring or issuing $2.5 billion of future GARBs.

The suit had forced Chicago to put on hold a $1.1 billion bond sale secured by PFCs and federal grants. Under the pact, the city and the airlines will return to the bargaining table by March 2013 to settle on a timetable for the remaining projects that are part of a larger $8 billion expansion program first announced by Daley in 2001.

“This is a landmark achievement that will benefit air travelers throughout the entire nation,” said U.S. Transportation Secretary Ray LaHood. “Making improvements to O’Hare will not only reduce flight delays and improve service for air passengers across America, it will ensure one of our busiest airports continues to thrive economically in the future.”

Daley, who did not seek re-election to a seventh term and will leave office May 16, thanked LaHood and U.S. Sens. Richard Durbin, a Democrat, and Mark Kirk, a Republican, for their work in brokering the settlement. “Unless we continue to modernize its infrastructure and operations, we will lose our competitive edge in the global economy,” Daley said.

Gerard Arpey, chief executive officer of American Airlines, said in a statement: “The parties have crafted a plan that recognizes the turbulent conditions of our industry and allows us to continue a dialogue with the city over the best timing and pacing of construction going forward.”

Chicago had wanted to complete the overall $8 billion O’Hare Modernization Program by 2014, but the airlines wanted it to adhere to a schedule tied to operational triggers based on passenger and flight growth. The price tag on the final phase is $3.36 billion. The city completed financing for the first $3.3 billion phase that airlines previously approved. Plans for a new $2 billion terminal that is part of the overall program remain on hold. Under the new timeline, the overall program likely won’t be completed until at least 2016.

Pete Scales, a spokesman for the city’s Finance Department, said officials could not comment until at least Tuesday afternoon on the agreement’s impact on the delayed PFC-federal grant bond sale, including its sizing, timing and structure.

A hearing had been scheduled before Cook County Circuit Court Judge Richard Billik Jr. Tuesday on the city’s motion to dismiss the lawsuit and hearings that were scheduled later in the week on the airlines’ request for an injunction blocking the projects and their financing.

The bond sale includes a mix of passenger facility charge bonds and others backed by both PFCs and federal grants. Chicago officials planned to take retail orders on Feb. 1 and hold an institutional pricing the next day. Citi is the book-running senior manager and Siebert Brandford Shank & Co. is co-senior.

As talks with the airlines stalled last year, the city put together a financing plan that officials believed bypassed the need for airline approval. To raise funds for the spring construction season, it intended to sell the PFC- and grant-backed bonds that don’t require airline authorization.

Under the existing pact, airlines do have a say in projects funded with GARBs, since their rates and charges repay the debt. But the city believed it could begin issuing GARBs later this year under its plan because it planned to delay debt-service payments until after the existing airline-use agreement expires in May 2018.

The airlines believed the city’s attempt to finance the completion phase projects breached its contractual rights under the use agreement. While the use agreement does not give the carriers a say on projects to be paid for with PFCs or federal grants, the airlines believe those projects should be blocked because GARB proceeds ultimately will be needed to complete them.

The city unveiled the OMP in 2001 to expand the airport’s capacity and reduce air traffic delays caused by the shutdown of intersecting runways during poor weather. When the expansion is completed, O’Hare will have six parallel runways and two crosswind ones compared to its current seven intersecting pattern. The FAA approved the plan in 2005.

Fitch Ratings recently downgraded O’Hare’s PFC and third-lien GARB ratings, and Moody’s Investors Service shifted its outlook on the third-lien GARBs to negative. The actions came before news of the lawsuit.  Fitch rates O’Hare’s PFCs A-minus. It assigns an A-minus to the third-lien GARBs, a AA to the second-lien GARBs, and a AA-plus to the first-lien GARBs. Moody’s rates O’Hare’s PFCs A2 and its second- and third-lien GARBs A1. It rates the first-lien GARBs Aa3.

Standard & Poor’s rates Chicago’s PFC bonds A-minus. It rates the third-lien GARBS A-minus, the second-lien GARBs AA-minus, and the first-lien GARBs AA. The city has $816 million of outstanding PFC-backed bonds, $5.1 billion of third-lien GARBs, $369 million of second-lien bonds, and $73 million of first-lien bonds.

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