RBC is senior manager for Chicago's conversion of $112 million of floating-rate sales tax-backed bonds to a fixed rate.

CHICAGO — Chicago heads back into the market Wednesday to convert $112 million of floating-rate sales tax-backed bonds to a fixed rate, further chipping away at bank credit risks that posed a $2.2 billion liquidity risk to the city's balance sheet.

RBC Capital Markets is the senior manager with another 12 firms in the syndicate and Sycamore Advisors LLC advising the city. The bonds mature through 2034.

The city posted an investor presentation with its offering statement last week and is holding investor calls promoting strong coverage and bondholder protections on the sales tax credit, which is rated AAA by Standard & Poor's.

The conversion of synthetically fixed bonds from a 2002 issue is a "continuation of financial reforms" announced recently by Chicago Mayor Rahm Emanuel that will "eliminate variable rate and swap risks" tied to the city's general obligation and sales tax credits, new chief financial officer Carole Brown tells investors.

The city last week priced $670 million of GOs that, along with funds from its short term borrowing program, converted floating-rate paper from 2002, 2003, 2005 and 2007 bond series to a fixed rate.

The combined deals allow Chicago to get out of swaps, credit lines, and credit facilities on which triggers and default events were created when Moody's downgraded $8.9 billion of Chicago GOs, motor fuel and sales tax bonds to junk on May 12. Moody's also lowered $3.8 billion of water and sewer bonds to lower investment grade levels.

In addition to shedding bank support on the $912 million of floating rate GO and sales tax paper, the city is making termination payments to exit $200 million of swaps on the GOs and $30 million on the sales tax debt.

JPMorgan Chase is the swap counterparty and provides support on the sales tax bonds. The city has struck a forbearance with the firm precluding it from demanding repayment. "The pricing and closing of the [sales tax] bonds resolves this issue," Brown said. The closing is expected June 8.

The city will cover the sales tax swap termination costs with available funds in its sales tax revenue fund.

Standard & Poor's affirmed the bonds' AAA rating in March. Fitch Ratings links the rating to the city's GOs so they carry the same BBB-plus rating, which is on negative watch. The city did not seek a Moody's rating and Kroll Bond Rating Agency published a new rating on the credit of AA-plus Tuesday. 

Moody's also rated Chicago sales tax bonds at the same Ba1 level as its GOs, reflecting the absence of legal segregation of pledged revenue from the general operations of the city. "This lack of separation caps the ratings at the city's GO rating, despite sound maximum annual debt service coverage provided by pledged revenue," Moody's wrote.

The bonds are secured by revenues from the city's 1.25% home rule sales and use tax, as well as the city's 16% allocation of revenues from the state's 6.25% sales and use tax.

The investor presentation stresses the city's home rule status, which gives it flexibility to raise the sales tax rate; a structure that directs pledged revenue to a segregated fund; and a pledge to maintain at least a one times coverage ratio.

The actual ratio is 16 times based on outstanding debt and the city has no plans to add to the $541 million outstanding under the credit, said deputy comptroller Jeremy Fine and assistant comptroller Michelle Curran.

The city stands to trim its yield penalties demanded by investors given the underlying strengths of the credit compared to what it paid on the GO conversions, but a steep differential is still expected, market participants said.

On its GO conversion, the city paid a spread of 293 basis points to Municipal Market Data's top benchmark on its 10-year maturities and 264 basis points on its longest, 27-year maturities. Secondary trading late last week cut the spreads by about 25 basis points, market participants said. Spreads after the Moody's downgrade shot up to a high of 300 basis points.

Several market participants said the city heads into the market in a stronger position this week given its success in getting the GO conversion deal completed and also stands to benefit from the General Assembly's  passage of legislation easing a $550 million spike due next year in public safety contributions.

Brian Battle,  director of trading at Performance Trust at Capital Partners, said he didn't see much change in trading on Chicago debt Monday and said he didn't expect the pension relief bill would have much effect on trading levels. "The legislation is proposed, not signed," Battle said. "This is short term legislative relief for the city, it does not change the economic answer."

"We are waiting to see if the governor signs it. That would be a signal of his posture on a lot of issues. The governor is in a tough spot given decades of underfunding and budget imbalances. I think if he signed it, it would be in combination with other reform minded  legislation," Battle added. Rauner signaled just that Monday.

The GO conversions will add at least $43 million in direct interest costs to the city's balance sheet according to its revised debt service schedule. That figure doesn't include the added interest associated with the use of short-term borrowing to cover about $130 million of the conversion costs.

The city still faces bank risks on more than $600 million of outstanding short-term debt although it has forbearance agreements that run 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. The city has not provided an update on the status of negotiations with impacted banks.

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