CHICAGO — Chicago will enter the market this week with $280 million of new-money and refunding wastewater revenue bonds and follow up next week with $500 million of new-money and refunding water revenue debt. The deals will include Build America Bonds and qualified energy conservation bonds.
George K. Baum & Co. is senior manager on the second-lien wastewater bond sale and Acacia Financial Group is financial adviser. The city will take retail orders Monday and open up the sale to institutional buyers Tuesday.
Cabrera Capital Markets LLC is senior manager on the second-lien water revenue bond sale and TKG & Associates is financial adviser. Retail orders will be taken Nov. 2 with institutional pricing the following day.
The two sales are expected to escape the investor penalty other Illinois issuers have experienced as a result of the state’s liquidity and budget crisis. Chicago’s own budget woes and recent downgrades of its general obligation rating also should not affect the deals, market participants said.
“These deals won’t suffer,” said Thomas Spalding, senior investment officer at Nuveen Investments. “It’s an enterprise system and the city has flexibility to raise rates.”
The sale this week is made up of $30 million of second-lien wastewater transmission revenue refunding bonds and $250 million of BABs. The BAB proceeds will finance the system’s capital needs for the next three years. The system’s 2010-2014 capital program totals $801 million. The bonds are repaid with system revenues that primarily come from rate payers on a second-lien basis.
The federal interest rate subsidies the city expects to receive under the stimulus bond programs are not pledged to bond repayment, according to offering statements. The city intends to tap the 2011 subsidies to help reduce its $654 million budget deficit. Future use of the subsidy will be decided annually, officials have said. Chicago’s wastewater system is responsible only for transmission. Treatment is managed by the Metropolitan Water Reclamation District of Greater Chicago, which consists of 4,400 miles of sewers that transport waste to district treatment plants.
Fitch Ratings affirmed its AA rating on $1 billion of second-lien bonds but revised its outlook to stable from positive on the credit since the system’s financial position has not improved much despite a series of rate increases approved in 2007.
Moody’s Investors Service affirmed its Aa3 and stable outlook on Chicago’s second-lien bonds and Aa2 on $27 million of senior-lien bonds.
Standard & Poor’s affirmed the second lien’s A-plus rating and the senior lien’s AA-minus. The outlook on both is stable.
“The rating reflects our view of the city’s large, diverse customer base and adequate reserves that are buoyed by the presence of a rate-stabilization fund to augment liquidity,” said analyst Helen Samuelson.
Sewer rates since 2000 were set at 83% of water system rates, but were hiked to 84% in fiscal 2008, with additional ratio increases to 85% and 86% in 2009 and 2010, respectively. The system’s coverage ratios have been consistently low over the last three years at 1.07 times in 2007 and 2008, and down to 1.02 times in 2009, despite the rate hikes.
The system’s liquidity is bolstered by a rate stabilization fund balance of $14.6 million.
The water sale includes $33 million of bonds that will refund outstanding debt for savings as well as $423 million of BABs and $30 million of qualified energy conservation bonds that will provide new funding for qualified capital projects. The bonds are secured by the net system revenues that come from consumer payments on a second-lien basis.
Ahead of the sale, Fitch downgraded its rating on $140 million of senior-lien water revenue bonds to AA-plus from AAA and its rating on $1.3 billion of second-lien bonds to AA from AA-plus.
Standard & Poor’s affirmed its ratings of AA-minus on the second-lien and AA on the senior-lien bonds. The system’s large and stable customer base, good liquidity, and low rates — even after rate hikes — offset concerns about declines in debt-service coverage ratios.
Moody’s affirmed its Aa3 on the second-lien water bonds and Aa2 on the senior-lien but revised its outlook to stable from positive.
“The revision of the outlook to stable from positive is primarily based on the coverage levels not increasing to higher levels despite three years of consecutive rate hikes,” Moody’s wrote.
Fitch attributed its downgrade to the gradual erosion of financial flexibility in recent years along with rising debt levels.
The system’s capital improvement program calls for nearly $1 billion in spending through 2014. Funds from the upcoming sale are expected to cover project costs for the next three years.
The City Council adopted a rate increase package in 2007 that raised user charges over 50%, but debt-service coverage on senior- and second-lien bonds combined was at 1.3 times last year due to wet weather and conservation efforts, down from an expected rate of 1.5 times. Coverage is expected to improve to 1.6 times this year but will fall to 1.1 times by 2012.
The system closed out 2009 with $21.5 million in unrestricted cash and investments with additional liquidity coming from a rate stabilization account that holds $51 million.
The system’s diverse service area, which includes the greater Chicago area, is a credit positive. The water system has nearly 500,000 accounts that serve more than 5.3 million people. One of the utility’s two water purification plants on the Chicago lakefront is the largest in the world.
Illinois and the seven other Great Lakes states signed a memorandum of understanding in 1996 that established regional cooperation for water utilization. The city agreed to lower its use after its partners charged it with exceeding limits.
Chicago has implemented measures to limit leakage issues. It has shifted to meters for large industrial users and new residential construction and is promoting the same shift for existing residential users. About 36% of accounts are metered. As a result, daily volume water transmission declined to 809 millions of gallons per day in 2009 from 1,015 in 1998.
Bank of America Merrill Lynch said in its municipal commentary on Friday that it believes Chicago will need to raise rates to improve coverage ratios and the low level of its existing rates give the city the flexibility to take such action. As debt-service coverage has fallen, outstanding second-lien water bonds from 2006 and 2008 issues have cheapened, trading 12 basis points to 30 basis points cheaper to the Bank of America AA water index.
