CHICAGO – The Chicago Infrastructure Trust will launch a search for a placement agent to market a financing that closely resembles a tax-exempt private placement to raise funds for its inaugural set of projects.
The trust’s board Friday authorized Chief Executive Officer Stephen Beitler to conduct a competitive selection process for a placement agent whose job it will be to gauge investor interest, develop, and advance the proposed structure that officials described as “concept” still in the works.
The goal is to return to the board later this summer with recommendations that could lead to an offering memorandum and competitive selection process for investors to fund nearly $100 million in energy efficiency upgrades to city facilities and Chicago Public Schools. The city eventually hopes to fund a total of $200 million of projects under Retrofit Chicago in a series of financings.
The trust board will eventually decide whether the alternative offered by the trust “is the best value to the city” in terms of pricing, said board chairman James Bell, and the “city has to decide whether it’s worth it.”
Movement on its first financing comes as the trust faces both market and public scrutiny as to whether it will live up to its billing by Mayor Rahm Emanuel as an innovative financing vehicle for special public works projects.
Emanuel promoted creation of the trust as a means to tap alternative investors without impacting the city’s balance sheet while preserving the city’s stretched bonding capacity. Emanuel unveiled plans for the trust in March 2012 alongside former President Clinton.
Though an actual deal with actual terms is still to come, several board members launched a debate over whether the proposed structure resembling a private placement makes fiscal sense when held up against the low costs of traditional city general obligation and revenue-backed borrowing.
Bell and others also raised the specter of Moody’s Investors Service’s downgrade last week of $11.5 billion of city debt, including a dramatic three-notch downgrade of the city’s GO rating which will drive up city borrowing costs.
City and trust officials said the steep downgrade and negative outlook, driven by the city’s massive unfunded pension liabilities and concerns over a looming $600 million increase in 2015 pension payments, underscore the trust’s objective as an alternative financing vehicle .
Moody’s also cited the strain posed by the city’s high debt levels and Emanuel’s reluctance to raise revenues among strains on the city’s balance sheet.
Officials also stress that little help can be expected from the state which has seen its GO rating tumble over legislative inaction on pension reforms. Moody’s now rates both Illinois and Chicago GOs A3 with a negative outlook.
The proposed structure outlined at the board meeting is still in preliminary form. It envisions the creation of a Grantor Trust by the agency that would serve as the vehicle for offering the proposed securities.
The securities would be privately placed on a tax-exempt limited recourse basis and repaid with energy savings and operating and maintenance savings. A legal review would still be needed on the individual projects or reimbursements to ensure they qualify for tax-exempt financing.
A public policy decision on the value of the financing and whether it meets the city’s policy and finance goals likely will take center stage ahead of the trust’s approval of any deal. CIT is hoping to review and approve a transaction as soon as September, if it decides to proceed, with a City Council and CPS review following as soon as October.
The city previously envisioned a quicker timeline with a closing this summer but the need to craft a structure that could draw sufficient investor interest while also keeping borrowing rates affordable forced the city to rethink structural issues.
Under the proposed structuring idea, the agency would enter into loan agreements with the three recipients of funds – two city departments and CPS -- and the Grantor Trust would be secured by the various savings and an equity indemnity reserve facility funded on a second lien basis. The EIRF would in effect serve as a reserve to cover a potential first loss in the range of 10%. The fund would hold a second lien on the pledged repayment stream.
The agency would sell securities dubbed Trust Participations to investors through the Grantor Trust mechanism with loan repayments flowing through the agency to the Grantor Trust and then to investors.
The structure, labeled a “concept,” was crafted by Kutak Rock LLP and closely resembles a traditional private placement used by issuers in the tax-exempt bond market. The firm was hired by the city’s law and finance departments after discussions with potential investors.
The city “avoids using city and CPS general obligation bond capacity and protects taxpayers,” an outline says.
Kutak partners Jerry Wallack and Dennis Holsapple, both bond counsel veterans of public finance transactions for Chicago, outlined the structure for the trust’s voting and advisory board members.
The structure, potentially, allows for the securities to be sold on a tax-exempt basis which would be “passed through up to investors,” Wallack said.
The structure meets a series of city goals by transferring some project risks and freeing up borrowing capacity for other uses. The structure is modeled after a private placement so it’s familiar to traditional institutional investors while limiting city liabilities.
Officials said the novelty of the transaction would stem from the monetizing of savings expected from the energy upgrades – a revenue stream that does not yet exist. The financing would also blend the credit of three separate systems, two city departments and CPS and would achieve transactional savings through the combination.
“It’s a very goal driven structure that meets public policy goals,” said David Winters of the city’s Law Department.
The proposed structure evolved after officials ran into financing obstacles from potential bidders whose interest was dampened by the lack of a city guarantee. Investors wanted the structure to “look more like a tax-exempt bond” to offset the lack of credit support from the city, said Scott Falk, a partner at Kirkland & Ellis LLP, which is advising the trust. The proposed structure brings the potential deal into the “neighborhood where the rates will be acceptable to the city and trust,” he said.
The benefits of the structure include the partial transfer of project risk to private investors, the potential to keep the financing off the city’s balance sheet and retained ownership of the assets. It’s unclear whether the structure would draw interest from the alternative types of investors such as pension funds, equity funds, and foundations.
Updated financing requests from the city’s water department, Fleet and Facilities Management, and Chicago Public Schools put the financing total at about $86 million.
CPS would account for about $20 million of the initial financing to install high efficiency light bulbs in facilities. The goal is to generate $18 million in financing. An estimated $2.2 million in annual savings would go to repay investors over a projected 10-year term.
The Department of Water Management is seeking $40 million in funding with $4.6 million in savings from reduced labor, maintenance, and energy savings expected to repay investors based on a 15- to 20-year financing term.
The Department of Fleet & Facility Management is seeking $26 million in funding with $2 million in annual energy savings expected to support a 20-year repayment term.
The CPS projects generated a debate sparked by questions over the district’s decision to go ahead and install the new lighting. The trust would, in effect, be reimbursing the district for capital costs. “What it comes down to is, what are they asking us to go out and finance? And how do they get to that number?” Bell said.
Board members also raised questions over a Chicago Tribune article that found the district had spent about $300,000 to install upgrades in schools now slated for closing this summer. The district is closing nearly 50 schools as it grapples with a $1 billion deficit. “It raises an eyebrow in my mind,” said board member David Hoffman, a former federal prosecutor and former city inspector general.
Hoffman also grilled Beitler and city representatives on how the savings figures were reached. While savings initially were projected by CPS and department officials the trust has hired its own industry recognized experts to assess the savings, Beitler said.
While the board, which includes five voting members and six advisory members, face a more in-depth debate over the value of the financing once the terms and borrowing levels are set, several board members offered a preview. Advisory member Stephanie Neely, the city’s elected treasurer and a former public finance banker, questioned the higher cost of raising capital through the use an alternative structure.
Wallack said it would be the city’s decision as to whether the cost of capital “is worth the relief” on the city’s tax base.
Advisory board member Damon Silvers, director of policy and special counsel for the AFL-CIO, summed up the argument. “This is the critical tradeoff” freeing up the city’s access to capital for other infrastructure work “against the possibility that sometimes the structure will have higher costs.”
The slow pace in advancing the agency’s first financing after the fanfare of trust’s unveiling has fueled critics’ questions over its value. Officials counter that the slow track shows all involved are conducting the proper due diligence in creating a policy and financing template that meets the city’s goals on both fronts. They also argue the slow pace and lengthy debate Friday illustrate a commitment to transparency.
While some veil will remain on financing terms during negotiations, lest the city and trust risk showing too much of their hand to investors, the hours-long public discussion that dipped “into the weeds” of the financing structure is a rarity for city borrowings. They are more typically packaged and brought to the City Council’s Finance Committee where questions tend to be limited to community impact, job creation, and minority participation in finance teams.
Any use of private investment involving pubic assets faces heightened scrutiny in Chicago due to public and political angst over problems with former Mayor Richard Daley’s $1.15 billion privatization of the city’s parking meter system in 2009. Rates have skyrocketed and Daley spent most of the proceeds to balance his last few budgets.
While the trust’s work is still focused on the energy retrofits, Beitler outlined several other areas of interest. They include future energy related projects involving solar, wind, and geothermal heating. Another targeted area is transportation with the trust beginning discussion with the Chicago Transit Authority. The trust also intends to target underutilized city owned properties and air rights.
One vocal trust critic, civic activist Tom Tresser, said he remains skeptical. “I believe that the Chicago Infrastructure Trust is simply the parking meter scam dressed up,” he said. “The mayor’s people avoid the word ‘privatization’ and call these deals ‘public-private partnerships.’ But, to me, it’s still going to the payday loan store for cash to improve our city.”
The trust in April received responses from 13 financial firms or groups in its first solicitation of private market interest. The city last year announced nonbinding agreements from Citibank NA, Citi Infrastructure Investors, Macquarie Infrastructure and Real Assets Inc., JPMorgan Asset Management Infrastructure Group and Ullico to consider investing up to $1.7 billion.