Chicago finds refunding savings in downsized securitization deal
CHICAGO — Chicago officials declared success after selling its latest securitization deal following a two-week delay during which the finance team cut the size, shelved a 2053 maturity, and tinkered with coupons to cater to investor appetites.
The $615 million Sales Tax Securitization Corp. deal refunded Chicago general obligation bonds, “so we always had a savings target of 3% net present value,” and by meeting that threshold the deal achieves the “budgetary relief savings we anticipated,” said Carole Brown, the city's chief financial officer.
The tax-exempt spreads on the $615 million sale widened from the city’s previous two STSC deals, but “the goal is to achieve lower cost of financing” compared to the general obligation credit “and we continue to do that,” Brown said.
Spreads, though wider, remain in line with what bankers said the city could achieve when it launched the program. The borrowing program is designed to provide both present value savings and $700 million in five-year budget relief by smoothing out the city’s GO debt service schedule.
The city brought the $615 million issue Thursday after a two-week delay during which the city and its finance team tweaked the deal, trimming it from an upsized $1.3 billion, dropping a taxable tranche and limiting the final maturity to 2048.
The finance team recommended moving forward Thursday with the transaction and settled on the sizing and structure during the two-week delay as the underwriting team “did its job and continued to canvas the market and make adjustments,” Brown said, praising bookrunner Loop Capital Markets LLC for “helping the corporation achieve its objectives.”
Looking at other deals, Brown said of the decision to cut the 2053 maturity that “there’s just been a lack of demand in the longer end,” especially amid a flattened yield curve.
The deal’s spreads between the single-A and triple-B benchmark landed where expected, said several market participants.
An S&P Global Ratings criteria change for priority-lien tax revenue credits may have factored in market sentiment. Because of that change, S&P on Oct. 23 dropped STSC debt one notch to AA-minus. A week later, it cut the state government's sales-tax backed Build Illinois bonds five notches to BBB from AA-minus.
“I think unfortunately they were impacted by S&P’s rating methodology change and the taint of the downgrade of the state’s sales tax bonds. On top of that, you have negative mutual fund cash flows and retail has been quiet. All that combined for a tougher market, but they got the deal done,” said Lyle Fitterer, head of tax-exempt fixed income for Wells Capital Management.
It was Chicago's third deal under a $3 billion borrowing program approved by the City Council in 2017 using the securitization structure that state lawmakers put into place earlier that year allowing for the creation of a special purpose, bankruptcy-remote entity.
The three tranches have offered varying maturities, coupons, and the previous two had taxable tranches so direct comparisons are hard, but overall tax-exempt spreads widened from the previous deals, particularly the first in December 2017, when the city had fortuitous timing as yields were falling and investor dollars bountiful.
Chicago will return as soon as January with a final tranche for about $600 million.
The deal led by senior managers Loop and Stifel with Loop running the books was repriced with serials from 2022 to 2036 offering coupons at 5%, 5.25%, and 5.50%. Yields ranged from 2.75% on the short end to 3.96% on the longer end.
The higher coupons provide more protection on the bonds’ trading value should rates move higher.
The 2043 term bond for $41.5 million offered a 5% coupon and yield of 4.15% at a price of $106.9. A second 2043 term for $91.5 million offered a 5.25% coupon and yield of 4.08% at a price of $109.5. The $164 million 2048 term offered a 5.25% and yield of 4.16 and price of $108.8.
The deal came with two triple-A ratings and S&P's AA-minus.
The 10-year offered a 5% coupon with a yield of 3.48% and price of $111.7, an 80 basis point spread to the Municipal Market Data’s AAA benchmark, more in line with the BBB benchmark spread. Spreads on the term bonds ranged from 68 bp to 81.
The inaugural $744 million December 2017 securitization included a $172 million tax-exempt tranche with maturities from 2020 to 2030, with the 10-year yield landing at 2.22% for a 34 basis point spread to MMD.
The second tranche for $680 million priced early this year after a brief delay during the city tinkered with the deal to accommodate post-federal tax reform market conditions. The $376 million tax-exempt tranche matured serially from 2031 to 2038 with the 2038 landing at 3.18%, a 50 basis point spread to MMD.
The early 2018 deal ranged from a 52 to 61 basis point spread to the benchmark while spreads on the December 2017 sale ranged from 26 bp to 43 bp based on the market close benchmarks, according to the city's calculations.
The city had long planned a third tranche for $665 million. Based on what looked like strong demand during investor meetings, the city decided to raise it to $1.3 billion to wrap up the program ahead of Mayor Rahm Emanuel’s exit in May. He announced in September he won’t seek a third term.
Facing market and credit headwinds, the city decided just ahead of the Oct. 31 pricing date to delay it. Rates were on the rise and demand was also soft marketwide on the long end.
The market was also just digesting S&P's superdowngrade of Build Illinois bonds the day before.
The Build Illinois and STSC structures are far different, but the state downgrade still caused market jitters.
“I think there’s the fear S&P may change the methodology” in the future even more closely linking the securitization structure to the city’s underlying credit, Fitterer said.
The deal also raised some concerns among investors, a budget watchdog, and some aldermen because the planned 2053 maturity went out 13 years past the final maturity on bonds being refunded and 10 years past the final maturity on any city GO. The $1.3 billion version had $900 million in the final maturity while the original $665 million deal had $409 million in it.
Brown said the final transaction’s final maturity will be dictated by what’s needed to meet the program’s goal of leveling out debt service to provide more budget certainty going forward without pulling too much sales tax revenue out of the corporate fund to repay the securitization.