CHICAGO — Chicago enters the market this week with more than $400 million of mostly new-money water revenue bonds in its first borrowing to benefit from recent rate hikes that paved the way for an acceleration of projects under a five-year, $1.67 billion program.
Siebert Brandford Shank & Co. is senior manager with another nine firms in the underwriting syndicate. Perkins Coie LLP and Shanahan & Shanahan LLP are co-bond counsel. Phoenix Capital Partners LLP is advisor. The deal includes a mix of serial and term maturities.
The second-lien bonds will refund about $35 million of commercial paper with the remainder providing new money for maintenance of the city’s purification plants, upgrades to various pumping stations, replacing water mains and installing new meters. The city has authorization to issue up to $750 million under its ordinance so refunding bonds may be added to the deal if present-value savings are available.
The bonds are secured by system revenues, mostly from user fees. With existing debt straining coverage ratios and limiting future issuance, Chicago Mayor Rahm Emanuel last year won City Council approval for a four-year rate hike package to accelerate upgrades. It will raise rates by nearly 90% from 2011 levels.
“The upward adjustments are expected to lead to a material improvement in financial performance as well as escalating surplus revenues available for capital expenditures,” Fitch Ratings wrote in its report. Ahead of the sale, all three rating agencies affirmed the double-A level ratings assigned to the system’s first- and second-lien debt. Fitch also revised its outlook on the credit to positive.
The city still faces the so-called Illinois penalty that forces most issuers to pay more to borrow to place their paper, even higher-rated credits with few financial woes or vulnerability to chronic delays in state tax and aid payments. One investor said that’s due in part to the steady supply of debt from Illinois issuers, especially the state, which pays the steepest premium.
“Investors want to be adequately compensated” to absorb all the paper, said Thomas Spalding, senior portfolio manager at Nuveen Investments, which has a 20% limit on paper from individual states. “You have to make a decision on relative value.”
The 10-year maturities on the state’s $1.8 billion general obligation refunding last week paid yields 165 to 175 basis points over the triple-A MMD. Spalding said the city might end up paying about 75 to 85 basis points over MMD.
To combat the Illinois effect, Chicago and its finance team are doing a hard-court press with investors stressing the strength of the enterprise system given the rate hikes and the credit’s isolation from any state payment risks. The team initially considered pricing on Tuesday, but is waiting until Wednesday or Thursday given the interest of several institutional buyers who have not previously purchased city water bonds.
“We have had a lot of investor interest and we want to make sure they all get their questions answered,” said a market participant working on the deal
Fitch rates $1.6 billion of second-lien bonds AA and $69 million of senior-lien bonds AA-plus. Moody’s Investors Service assigns Aa3 and Aa2 ratings, respectively, with a stable outlook, and Standard & Poor’s assigns AA-minus and AA ratings, respectively, with a stable outlook.
“In our view, Chicago’s water system has a large, diverse, and stable customer base, which we consider a credit strength,” S&P analyst Corey Friedman said. The credit benefits from strong liquidity, competitive rates even with the recent increases, and strong total debt-service coverage. Challenges include moderately high leverage with additional issuance of $200 million planned annually over the next four years.
Debt service coverage, which had narrowed to 1.2 times, is projected to rise to 1.8 times this year and approach 2.8 times in 2015. The city’s water system which draws and treats Lake Michigan water serves more than five million people in the city and suburbs. The utility’s two water purification plants on the lakefront are among the largest in the world.