CHICAGO – Chicago’s Sales Tax Securitization Corp. bonds should find a welcome reception when the credit returns to the market Wednesday with a follow-up to its December debut.
While the city’s own general obligation ratings range from a low to junk to the high triple-B category, the $795 million of STSC paper carries a AA rating from S&P Global Ratings and AAA ratings from Fitch Ratings and Kroll Bond Rating Agency. All assign a stable outlook.
The paper is apt to be relatively cheap for the rating level because of the penalty the market imposes for the city and state’s fiscal woes and weak general obligation ratings, despite the structure’s insulation from the city’s corporate fund and its label as a bankruptcy-remote structure.
“They are bringing a good-sized deal with a good rating and they are bringing bonds where people want them for maximum yield,” Brian Battle, director of trading at Performance Trust Capital Partners, said referring the bulk of the sale in two terms on the long end.
The second outing could also help move some buyers sitting on the fence.
“You won’t be the first one buying a new name and you know the market can clear the bonds,” Battle said.
While so far there’s been little change in the market, Battle said many will be watching for the continued participation of C corporations given their reduced tax rates under the tax package President Trump signed in December and whether it will dampen interest on the long end.
Chicago had fortuitous timing in December as it priced on a day when yields were falling, while yields are currently up.
“The market has obviously been choppier over the last couple days but the city should benefit from a lack of supply so it will have the market’s attention,” Adam Buchanan, a senior vice president in institutional sales and trading at Ziegler, said Friday.
The fixed-rate bonds mature serially from 2031 to 2038 with most of the debt in term bonds tentatively set for $168 million due in 2043 and $431 million due in 2048. The inaugural sale of $744 million in December refunded the city’s sales tax bonds. The new deal refunds city GOs.
Goldman Sachs is running the books with Cabrera Capital Markets LLC in the secondary spot and four other firms participating in the underwriting syndicate. Columbia Capital Management and Swap Financial Group are advising the corporation.
Nixon Peabody LLP and Golden Holley James LLP are bond counsel. Mayer Brown LLP is counsel to the corporation and Cotillas & Associates is special disclosure counsel to the STSC. Chapman and Cutler LLP is special counsel to the city and Kutak Rock LLP is underwriters counsel.
The city sought to highlight the structural strengths.
“The agreement [between the city and corporation] provides an absolute and unconditional assignment and true sale of sales tax revenues and includes a non-impairment covenant of the city,” Carole Brown, the city’s chief financial officer and president of the STSC, said in an investor presentation about the transaction.
Brown and the finance team have beaten the drum on the legal case for the bankruptcy-remote structure and differences between Chicago's securitization vehicle and the Puerto Rico Sales Tax Financing Corporation, issuer of COFINA sales tax debt that became entangled in Puerto Rico's Title III bankruptcy process.
Some market participants have warned that the sturdiness of such structures can’t be known until tested in the courts, citing the COFINA bonds. Some also warn that the new structure could be abused by the city if it decides to add to its debt burden and they worry it hurts the value of existing GO holdings and damages pensioner rights should the city face future distress.
Those worries took a backseat to the market’s thirst for paper on the December deal that offered $175 million of tax-exempt paper and $400 million of taxable securities. It was five times oversubscribed with more than 70 traditional and non-traditional municipal investors, allowing the city to pare down initial yields.
The spread on the 10-year tax-exempt bond landed at a 23 basis point spread to the Municipal Market Data’s AAA benchmark and five bps over the AA. That compares to the secondary trading level of 170 bps on the city’s GOs.
The city’s share of sales taxes that flow from the state -- $660 million in 2016 – now goes directly from the state to the corporation. After deductions to cover debt service and operations, the revenue will flow to a residual account that can be returned to the city. The state legislation, ordinance and bond documents offer protections such as a statutory lien and non-impairment provisions on the pledged revenues.
Chicago last year sought out the state legislation to allow home rule units to establish such special entities to securitize revenue streams that flow from the state as a means to bypass its weak ratings and lower debt service costs. The city’s 2018 budget relies on about $90 million in debt savings from refundings under the program.
A second home rule municipality – Bridgeview – recently established a special entity and securitized its sales tax revenues. It only received a BBB-plus rating from Fitch because its pledged revenues lack the same healthy characteristics as Chicago.
The structural protections provide the underpinning for Kroll’s top rating. Chicago deep and diverse economic strengths, the broad base of goods and services included in the pledged revenues combined with a long track record of collection and distribution, and the four times coverage requirement for future issuance add to the credit’s strengths.
Kroll said a primary credit concern is the “high overall sales tax rate in the city” that “may weaken growth of the pledged sales taxes.”
After the sale, the city has room to issue about $1 billion more of senior lien debt before bumping up against the four times coverage requirement. The city could use a subordinate lien but has no plans to do so, Kroll said. The City Council has authorized up to a total of $3 billion of issuance.
“The bankruptcy-remote, statutorily defined nature of the issuer and a bond structure involving a perfected first lien security interest in the sales tax revenues are key credit strengths that lead Fitch Ratings to consider the corporation's credit quality as distinct from the city of Chicago,” Fitch wrote in its review.