CHICAGO – Chicago heads into the market Wednesday with $440 million of second-lien wastewater revenue debt that moves the city closer to putting a $2.2 billion liquidity headache behind it.

The liquidity concerns were triggered by rating downgrades.

The city will refund $332 million of floating-rate debt from 2008, converting the tax-exempt debt to a fixed rate and shedding direct purchase agreements.

The city also will price up to $107 million of taxable wastewater bonds to repay a line of credit used to cover swap termination payments on derivatives tied to the original transaction. Both have a final maturity of 2039.

Ramirez & Co. Inc. is senior manager. Mesirow Financial Inc. and The Williams Capital Group LP are co-seniors with another five firms rounding out the syndicate. A.C. Advisory Inc. is advising the city.

The city’s deputy comptroller, Jeremy Fine, tells investors in a presentation that the transaction will bolster the wastewater credit as it will “mitigate risks associated with our variable rate and swaps on the credit.” All of Chicago’s roughly $1.7 billion of the wastewater debt will bear a fixed rate after the transaction.

Swap terminations and defaults were triggered on direct purchase agreements and derivatives tied to the 2008 floating-rate securities after Moody’s Investors Service lowered its ratings on the city’s water and wastewater debt to the triple-B category. The downgrades came in tandem with its junking of the city’s general obligation credit in May. All the downgrades triggered defaults on contract terms that could have allowed banks to demand repayment on $2.2 billion in GO and revenue paper and swaps.

After the transaction, the city will have resolved all but about $100 million in swap termination events tied to its water credit.

The city heads into the market with some positive momentum on the credit after taking a previous hit.

Standard & Poor's, which had lowered the rating three notches due to the liquidity risks posed by the termination events, raised its rating Monday on the senior-lien wastewater debt to A-plus from A and on the second lien to A from A-minus. The outlook is stable.

"The upgrade reflects our expectation that the wastewater fund's financial operations, which we currently consider strong, should be sustainable in the next two years," said Standard & Poor's analyst Scott Garrigan.

Because the city's debt portfolio no longer has any contingent liquidity risk, analysts said the ratings were removed from CreditWatch with developing implications.

The credit also benefits from rate hikes that have bolstered financial metrics and rates are still considered affordable, leaving room for further increases if needed.

Fitch Ratings affirmed the wastewater credit’s AA second lien rating and removed the credit’s rating watch negative placement. It assigned a negative outlook. The rating agency does not rate the system’s senior lien debt.

The bonds are secured by net revenues of the city's sewer system after the payment of operations and maintenance expenses. Fitch said the system’s fiscal performance is strong but it remains concerned over rising costs and weaker debt service coverage levels than previously expected.

“Projections have been revised downward in recent years in large part because of direct and indirect pension cost estimates,” Fitch said.

The system's financial profile has benefitted from multi-year rate hikes that raised operating revenues by nearly $149 million from fiscal 2011 to 2015. Strong revenue performance, coupled with limited operating expense growth, has boosted the system's margins and free cash flow, leading to a more robust liquidity position and financial capacity to address aging infrastructure, Fitch said.

The city’s 2015-2019 capital program for the system totals $1.6 billion. The city expects to issue about $900 million in additional debt to support the program.

While the city likes to highlight the position of its water and wastewater credits as enterprise systems that are separate from the city’s credit, rating agencies and investors have offered differing assessments.

Market participants said it’s difficult to assess the penalty facing the deal given the Chicago name and location in Illinois. Initial pricing talk put the spreads on the 10-year taxable piece at a 300 basis point spread to Treasuries. Brian Battle, director of trading at Performance Trust Capital Partners, said the credit is aligned with the city but it is “essential purpose revenue” credit which should help improve the pricing.

“While Fitch views the potential for spillover of financial pressures to the city's utility funds as unlikely beyond expected rising indirect costs, signs or indications of such spillover could be expected to result in negative rating action,” analysts wrote. “Fitch believes severe liquidity stress within the non-enterprise funds (including the general fund) would likely pose the greatest threat to the utility.”

The system provides collection of wastewater to approximately 2.8 million city residents. All wastewater treatment is provided separately by the Metropolitan Water Reclamation District of Greater Chicago.

Kroll Bond Rating Agency assigns a AA-minus to the bonds being sold Wednesday.

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