CHICAGO — Chicago is readying about $700 million of water and wastewater revenue bonds for sale, emphasizing to investors the mostly double-A level ratings that contrast with the city's battered general obligation standing.
"The credit strength of the city's water revenue bonds is rooted in providing an absolutely essential service to a large and growing geographic area with favorable demographics," the city's chief financial officer, Lois Scott, said in an investor presentation. The city's water system serves more than five million residents in Chicago and in 125 suburbs and has seen 23% growth between 1990 and 2010.
The second lien water revenue sale of nearly $400 million is set for Wednesday with PNC Capital Markets LLC running the books.
The bonds mature serially between 2015 and 2034 with term bonds in 2039 and 2044. Unlike the city's GO bonds, the structure doesn't delay principal repayment and offers level debt repayment.
Several investors said the city stands to benefit from the solid ratings, a dearth of supply, and the extra yield the bonds likely will offer. The market for several years has demanded some penalty from Illinois credits, especially state and Chicago-related ones, due to both the city and state's budget and pension struggles.
"Both Chicago and Illinois bonds have underperformed and I don't expect a change," said Thomas Spalding, senior investment officer at Nuveen Investments. "Whether you call it a single A credit or a double-A credit it's going to have to come with a little give on yield."
BMO Capital Markets and Siebert Brandford Shank & Co. LLC are co-senior managers and 10 additional firms round out the team as co-managers.
Pugh Jones & Johnson PC and Cotillas and Associates are co-bond counsel. Acacia Financial Group Inc. is advising on the deal.
The city will follow in the following week with a roughly $300 million wastewater revenue bond sale. Bank of America Merrill Lynch will be senior manager on the sewer deal, slated to price on Sept. 16.
Ahead of the sales, Kroll Bond Rating Agency assigned a first time rating of AA and a stable outlook to the water bonds. Fitch Ratings affirmed the second lien water bonds' AA rating and the AA-plus assigned to the senior lien. The outlook was revised to stable, down from positive.
Standard & Poor's affirmed the second lien's AA-minus rating and the senior lien's AA rating and stable outlook. The city will have $49 million of senior lien bonds outstanding after the issue and $2.3 billion under its second lien.
Moody's Investors Service has a less cheery view of Chicago's enterprise debt because of what it sees as entanglements with the fiscally strained city government.
It affirmed the A2 rating it applies to the city's senior lien water bonds and the A3 rating with a negative outlook to the second lien.
Chicago won an upgrade on its wastewater credit from Standard & Poor's, which lifted its rating one notch to AA-minus from A-plus on the second lien and to AA from AA-minus on the senior lien. A stable outlook was assigned.
"The upgrade reflects the city's actions to improve its financial position while addressing its capital needs in a timely fashion and still maintain rates that will not stress its service base," said Standard & Poor's analyst Corey Friedman.
Fitch Ratings affirmed the wastewater second lien rating of AA but revised its outlook to stable from positive. Moody's affirmed the wastewater ratings of A2 on the senior lien and A3 on the second lien with a negative outlook. Kroll assigned a AA-minus and stable outlook to the bonds. The city will have $1.6 billion of second lien bonds outstanding after the issue and $35 million of senior lien.
The water and sewer bonds are secured by net revenues of the systems that primarily come from user fees.
The city in an investor presentation attached to the offering statement on the water sale highlights the enterprise system's strengths, including what it describes as a diverse revenue stream from city and suburban customers. Drawing its water from Lake Michigan, Scott said the city has an "abundance of fresh water with no constraints in the near future."
The system has benefitted from a series of rate increases Mayor Rahm Emanuel pushed through in 2011 that has allowed the city to stabilize debt service coverage ratios and raise the percentage of projects financed with cash as the city embarked on a 10-year capital program.
Emanuel also took the controversial step of revoking the automatic exemption from water fees that most not-for-profits enjoyed.
The rate increases will lift the level of pay as you go financing to 40% by 2016 and rates remain competitive "compared to national averages" so there's room to grow if needed, said water department commissioner Tom Powers. Rates were raised 25% in 2012, then 15% in each of the next three years with subsequent increases tied to the consumer price index.
The 10-year capital program calls for the replacement of 880 miles of water mains, the installation of more than 200,000 water meters, and the conversion of four steam powered pumping stations to electrification which is more efficient.
The water department manages two main treatment plants, including the Jardine facility which is the world's largest and is capable of pumping and treating 1.4 million gallons of water daily.
Kroll said its water revenue bond rating reflects the city's "proactive steps to increase debt service coverage, improve liquidity, and address system capital needs."
Debt service coverage on the water bonds is expected to remain at 2.8 times this year, 2.7 times next year, and 2.4 times in 2016. A water rate stabilization reserve is funded at three months expenses.
The availability of water from Lake Michigan was described by Kroll as "a strong credit feature, especially since average daily usage is only about one-third of treatment capacity."
Fitch said the outlook change to stable from positive was due to increased pension funding requirements which it describes as "higher than previously envisioned although still manageable."
Under the city's state approved reform package for its municipal and laborers' funds, the water enterprise system's annual contributions for the cost of pensions for its employees will rise 25% annually over the next five years from a current base of $13 million.
In the investor presentation, deputy comptroller Jeremy Fine said the city continues to monitor its swaps and liquidity provider portfolio for opportunities to lower costs and raise the threshold for trigger events.
The city has three swaps on the water bonds, two with UBS and one with RBC, with a combined negative mark-to-market valuation of $92 million as of June 30.
