Chicago Sales Tax Paper Goes Down Better than Its GOs

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CHICAGO - Helped by a stronger revenue backing, Chicago's remarketing of $112 million of sales tax-backed bonds fared notably better Wednesday than its general obligation deal a week earlier.

That said, the city still paid sharp penalties, based on preliminary scales, of between 145 basis points to 170 basis points to Municipal Market Data's top-rated benchmark on paper rated AAA by Standard & Poor's.

Yields were trimmed three to five basis points in re-pricing, market participants said.

Ratings were all over the map; the bonds received an AA-plus rating from Kroll Bond Rating Agency, but Fitch Ratings and Moody's Investors Service cap the sales tax rating at the city's general obligation bond rating, which is BBB-plus from Fitch. Moody's, which was not asked to rate the sale, has the sales tax credit in junk territory, even with the city's GOs, at Ba1.

"The pricing looks pretty fair," said Brian Battle, director of trading at Performance Trust at Capital Partners. "Because of the triple-A it's getting better pricing than the GOs, but it's ridiculously cheap for a triple-A. It demonstrates the market penalty" for the city amid state political inaction on pension liabilities.

Market participants said they didn't think the legislature's passage of legislation easing a scheduled $550 million spike in public safety contributions next year had much impact. Market participants said the sales tax backing had appeal, providing a stronger city credit with still premium yields.

"This credit is based on the economics and economic activity of Chicago, but I think this deal is being seen an opportunity for some good credit in a bad city," said a Midwest trader.

"The dispersed ratings are definitely having an impact, there needs to be a comprehensive solution for Chicago. With Chicago's revenue stream, you can't over leverage the credit," said another trader. "I like this deal better than the deal last week. I hope this proves to be one the cheaper deals you can buy in Chicago."

RBC Capital Markets was senior manager on the reoffering of 2002 bonds that mature through 2034. 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.

According to preliminary pricing numbers, the bonds' final maturity in 2034 paid a yield of 4.67%, 170 basis points over MMD, and the 10-year paid 3.92%, a 165 basis point spread. The city's five year maturity saw a 145 basis point spread.

On a 2034 maturity, a single-A credit on the MMD scale would pay a spread of 61 basis points to the AAA and a BBB credit 102 basis points for comparable maturities.

The city saw steeper penalties last week on its GO remarketing following Moody's May 12 downgrade to junk of $8.9 billion of GOs, sales tax and motor fuel bonds.

On the GOs, Chicago paid a spread of 293 basis points to MMD on the 10-year and 264 basis points on its longest, 27-year maturities. Secondary trading late last week cut the spreads by about 25 basis points.

The city will use proceeds from this week's conversion to redeem floating-rate paper. The GO and sales tax deals allow Chicago to get out of swaps, credit lines, and credit facilities on which triggers and default events were pulled after the Moody's downgrade.

The triggers allowed banks to demand repayment of $2.2 billion, sparking a potential liquidity crisis that prompted Fitch and Standard & Poor's to downgrade the city's GO ratings, though they kept them at investment grade.

In addition to shedding bank support on the $912 million of floating rate paper, the city is making termination payments to exit $200 million of swaps on the GOs and $32 million on the sales tax debt. The city will draw from general sales tax revenues to cancel that swap with JPMorgan Chase.

Fitch has Chicago credits on negative watch due to the potential liquidity drain of the Moody's downgrade. Kroll and Standard & Poor's assign a stable outlook.

S&P's AAA rating "reflects our view of the city's strong legal provisions and consistently very strong revenue pledge," said analyst Helen Samuelson.

Kroll's rating is new.

"It is KBRA's understanding that the lien is contractual in nature and that it is applied to all sales tax revenues received by the city pursuant to the Home Rule and Local Share sales and use tax revenues that constitute pledged revenues," its analysts wrote.

The credit's central challenges are its exposure to economic conditions, pledged revenues that flow first to the city before being directed to a trustee-controlled fund leaving some risk they could be diverted under a distressed scenario, and uncertainty over the lien status in the event of a Chapter 9 filing, according to Kroll.

Chicago's GOs ratings range from Moody's Ba1 to A-minus from Standard & Poor's and Kroll's. Fitch rates Chicago's GOs BBB-plus. The city's GOs are on Standard & Poor's credit watch with negative implications. Kroll assigns a stable outlook.

The city's two remaining liquidity strains are posed by defaults on bank agreements supporting more than $600 million in short-term borrowing. 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 repayment of direct bank loans totaling $332 million and swap termination costs of $25 million. The city has not provided an update on the status of forbearance negotiations with impacted banks.

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