CHICAGO - Chicago took a beating but got its deal done as it offered its first general obligation bonds in more than a year Wednesday, with its fall to a junk-bond rating fresh on investors' minds.
The spread to Municipal Market Data's top benchmark on comparable maturities was 293 basis points on the city's 10-year maturities and 264 basis points on its longest, 27-year maturities.
The spread on the city's 10-year when it last priced GOs in June 2014 was 145 basis points, and had only been 84 basis points in 2013.
Spreads on some Chicago GOs - which had already traded at sub-investment-grade levels of 200 to 250 basis points - jumped as high as 300 basis points after Moody's Investors Service downgraded them to Ba1 May 12.
Market participants said the positive news is that the city got the $670 million deal completed - with $6 billion in orders -- after a tumultuous two weeks following the Moody's downgrade.
"Execution was the primary risk and the city needed all these deals done. This was a major step in addressing a potential drain on liquidity," said Matt Fabian, partner at Municipal Market Analytics. "I think this shows that at these prices Chicago has exceptional market access. They got their market access but it came at a cost. These are very attractive rates for lenders" when looking at credit risk.
Chicago Mayor Rahm Emanuel's new chief financial officer said she pleased with the results.
"Last month, Mayor Emanuel announced a financial plan that that would continue putting Chicago's fiscal house in order - including addressing the city's highly-leveraged legacy debt portfolio - and today we successfully executed one part of that strategy that will eliminate a substantial amount of taxpayer risk," Carole Brown said in a statement, highlighting the $6 billion order book.
"Investors remain confident in the city's credit and a secure economic future for Chicago," she said.
The underwriting syndicate led by Bank of America Merrill Lynch was inundated with orders after it initially offered yields that reflected secondary trading levels, according to market participants.
Many maturities were re-priced between one and 16 basis points in the city's direction, especially on the long end. "That's where there was maximum liquidity for trading purposes, and bigger allotments," said one market participant.
While demand was strong on the longer end, the syndicate did take down for their own inventories some bonds on the shorter end, according to market participants who could not say how much.
The city priced the GOs to convert floating-rate paper from 2002, 2003, 2005 and 2007 bond series to a fixed rate. The city will tap its short term borrowing program to complete the $800 million conversion, which allows it to shed a good amount of the bank credit risk threatening the city's liquidity.
The city received access to a new $200 million credit line from Morgan Stanley to redeem the portion of the $800 million "that does not fit under the existing property tax levy for the" original bonds, assistant comptroller Michelle Curran said in the investor presentation.
Market participants said the city benefitted from withdrawing its initial plan to offer the tranches separately, instead folding them together into one deal, and putting the market's top ranked underwriter last year at the helm to improve distribution and capital capacity. The city also launched a full-court investor press over the last week.
One advantage of the added bulk was the flexibility it provided the underwriting team in "catering" some structural details to market interest and demand.
The accomplishment of getting the deal done might soften the interest rate blow, but the city will feel the bruising on its balance sheet.
The city paid 5.18% on a 10-year maturity, unchanged from the preliminary pricing, for a 293 basis point spread over the Municipal Market Data's top-rated benchmark on a comparable maturity. The city's 22-year maturity priced at 5.78%, down from an initial 5.88%, for a 270 basis point spread. The city's longest maturity in 2042 paid a yield of 5.84%, after being re-priced downward from 6%, at 264 basis points over the MMD scale on a comparable maturity.
The deal means Chicago made a large dent in the $2.2 billion liquidity problem created by the Moody's downgrade to junk on $8.9 billion GOs, motor fuel and sales tax bonds. Moody's also lowered $3.8 billion of water and sewer bonds to lower investment grade levels. The rating actions pulled triggers and created default events on swaps, credit lines, and credit facilities.
The floating- to fixed-rate conversion and the termination of $200 million in associated swaps eases the strain. The city will return to the market in early June to convert $112 million of sales tax bonds and terminate an attached swap negatively valued at $30 million, further reducing its risk.
Triet Nguyen, a managing director at New Oak Capital LLC, said completion of the deal sets the stage for a potential rally of city bonds.
"Since the last 25 basis point move after Moody's can be attributed to the city's potential liquidity crisis, it makes sense that the market should retrace that move once the liquidity issue has been removed by today's successful placement," he said.
Nguyen said the deal appeared to draw strong across the board due to a shallow discount structure which is retail-friendly.
The bonds carried an A-minus rating from Standard & Poor's; the agency lowered the rating two levels and put the rating on CreditWatch with negative implications due to the liquidity strains created by the Moody's downgrade. Fitch Ratings lowered its rating one notch to BBB-plus from A-minus, and placed the credit on negative watch. Kroll Bond Rating Agency affirmed Chicago at A-minus with a stable outlook.
Moody's was not asked to rate the bonds, but in the end the city's interest rates reflected those of a junk credit. Headed into the deal, the MMD benchmark put a 10-year AAA credit at 2.25%, a single-A credit at 2.79% and a mid-level triple B credit at 3.21%. A 22-year-bond was at comparable MMD rates of 3.08%, 3.69%, and 4.10 %.
In its last GO sale in March 2014, Chicago's 10-year tax-exempt maturity yielded 3.95%, a spread of about 145 basis points to MMD, while its 2036 maturity yielded 5.18%, 161 basis points over MMD. The 2014 sale was Chicago's first after getting two three-notch downgrades the previous year, one from Fitch Ratings and the other from Moody's, over the city's pension funding strains.
Those yields marked a steep widening of spreads over the city's previous sale in 2013 when it saw a spread of 84 basis points on its 10-year and 89 basis points on its 22-year.
The city still faces bank risks on $600 million of outstanding debt in its short term borrowing program as bank support default events were triggered. Banks have entered forbearance agreements until Sept. 30 and the city said it is negotiating on extensions.
The city's water system faces swap termination risks of $110 million while the sewer system could face principal repayment of its direct bank loans totaling $332 million within a three to six month period as well as swap termination costs of $25 million, if demanded by banks. The city has not provided an update on the status of negotiations with impacted banks.