CHICAGO - Chicago intends to bring nearly $1.1 billion of general obligation bonds to market next week in a deal that allows it to discard remaining general fund liquidity risks tied to its credit deterioration by jettisoning expenses on to its long-term debt load.
The city heads into the market with a fresh credit blow from one rating agency and affirmations from two others.
The sale includes $344 million of tax-exempt bonds and $730 million of taxable bonds, with much of the sale moving short-term debt into a longer, fixed-rate term with capitalized interest for two and a half years. The deal offers of a mix of serial and term bonds with a final 2042 maturity. The deal's offering statement and an investor presentation were posted early Thursday.
Morgan Stanley is senior manager with William Blair & Co. and Siebert Brandford Shank & Co. as co-seniors.
"The city has embarked upon a series of reforms designed to build a stronger balance sheet, reduce taxpayer risks, and secure the city's long-term financial stability," the city's new chief financial officer Carole Brown said in the presentation.
The city said the transaction will eliminate liquidity risks on its general fund stemming from the May 12 loss of its investment grade rating from Moody's Investors Service. Brown and her team stress Mayor Rahm Emanuel's plan to phase out debt restructuring for budget relief by 2019, the city's plans to continue to build reserves, and its diverse and healthy economy and growing population.
Standard & Poor's late Wednesday downgraded the city one level to BBB-plus from A-minus, removed the rating from its CreditWatch with negative implications and assigned a negative outlook.
Fitch Ratings on Monday affirmed the city's BBB-plus rating, removed the credit from its rating watch negative and assigned a negative outlook. Kroll Bond Rating Agency this week affirmed the city's A-minus and stable outlook.
"The downgrade is based on our view of the city's structural imbalance, which we believe will necessitate the adoption of corrective budget measures over several years," said Standard & Poor's analyst John Kenward. "In our opinion, the city has not yet fully identified a credible plan to address the imbalance."
The rating agency said another downgrade could follow if no plan is outlined by the end of the year.
Brown countered in a statement that the rating agency failed to acknowledge city efforts to deal with its inherited pension reckoning. "As the city has always done to address budget deficits, we will roll out plans for addressing our legacy liabilities through the annual budget process so that we can continue to meet our obligations to workers, deliver vital city services, and protect our taxpayers," Brown said.
The administration has moved up release of the 2016 budget to September from October. It then plans to hold its annual investors conference to highlight the city's plans to tackle a roughly $420 million budget gap in its $3.5 billion general fund and a looming $550 million spike in police and fire contributions under a 2010 mandate to move to an actuarially required contribution from one based in statutes. The city also must fund a higher $100 million payment to its other two pension funds under a previously approved reform package, although the changes face a pending legal challenge.
State lawmakers approved legislation providing the city with about $200 million in relief from the $550 million spike by phasing in a shift to an ARC payment and extending by 15 years the schedule to get to a 90% funded ratio. Though it's unclear whether Gov. Bruce Rauner will sign the legislation, he did include the city's proposals in a sweeping pension reform bill announced Wednesday.
The divergence of the city's GO ratings sparked debate after Moody's pushed the city's rating down to speculative grade, casting a glaring light on the role of ratings in determining the value and risks of credits, especially ones under stress. Moody's, which was not asked to rate the upcoming sale, assigns a Ba1 and negative outlook to Chicago's $8 billion of GOs.
After the Moody's downgrade, Standard & Poor's lowered its rating two levels and Fitch lowered it by one notch. Those actions were due to the potential liquidity crisis posed by the Moody's downgrade, which triggered defaults on bank contracts tied to $2.2 billion of floating-rate paper, credit lines, and interest-rate swaps.
The removal of the negative credit watches this week stems from the city's success in easing that crisis through its recent conversion of more than $900 million in floating-rate GOs and sales tax bonds to a fixed-rate that shed bank support and swap terminations.
The upcoming deal further removes the remaining liquidity risks on the city's general fund by shedding bank supported credit lines now in default. The city's remaining liquidity risks stem from about $470 million of sewer and water related debts.
Brown recently portrayed the upcoming deal as a "cleanup" issue that lays the ground work for the city to address its $20 billion unfunded pension tab that has dragged down its credit and driven up borrowing costs to between 260 and 300 basis points over the Municipal Market Data's top-rated benchmark.
Proceeds will convert $677 million of debt in the city's short term borrowing program. Outstanding debt under those lines includes $192 million to cover GO swap termination fees, $170 million of debt service on a scoop and toss restructuring, $152 million that helped cover the city's recent conversion of floating rate GOs, a $62 million judgment tied to its parking garage lease, $42 million for increased bank fees due to downgrades, $35 million for a lease tied to the city's failed 2016 Olympic bid, and an $18 million claim tied to its parking meter lease.
The city also gets budget relief by building in about $170 million of capitalized interest into the deal for the first two years.
The city will use $180 million to cancel a 2005 leveraged lease transaction involving the Orange Line rapid rail transit line to Midway Airport. The Moody's rating triggered a default on the city's letter of credit reimbursement contract with PNC Bank. The city also will reimburse itself for the $24.5 million drawn from its general fund to cover swap termination fees on sales tax backed paper.
The city will leave about $140 million outstanding in its short term program and anticipates new agreements will allow it to maintain a program of between $500 million and $750 million.
"The city is currently negotiating with current and potential new credit providers for amended or new credit arrangements that would permit new borrowing under the short term borrowing program," city officials said in the presentation.
The city plans to return later this year or in early 2016 with a $700 million of GO borrowing that will include new money, further scoop and toss restructurings, and capitalized interest.
RATINGS
"The negative outlook reflects the uncertainty regarding the prospects for sustainable and affordable funding of pensions," Fitch said. "The outcome of the legal challenge to the city's pension reform legislation is still unknown and an adverse decision could cause a further downgrade." A lower court decision is expected soon on a legal challenge to the city's overhaul of its municipal and laborers' fund.
The weight of the city's pension burden is compounded by its substantial debt load as well as the pension burdens of other local governments that share the same tax base.
"The current issue includes some weakening elements to debt structure, including scoop and toss and two and a half years of capitalized interest, but importantly, reduces the city's vulnerability to accelerations of variable rate debt instruments," Fitch wrote of the transaction's downside and positives.
Kroll said it considers a strong management team that has improved the stability of financial operations to be a key credit strength. Other favorable factors include a substantial tax base, available reserves, and home rule status. "Willingness to raise property taxes remains to be demonstrated," the agency said.
Kroll's key credit concerns center on the city's pension burden and funding strains, a potential adverse court ruling on the municipal and laborers' overhaul, moderate to high debt levels with growing debt service and a slow amortization schedule. "In KBRA's opinion, political will is a crucial element in addressing these challenges," the agency wrote.
Standard & Poor's said its rating reflects the city's adequate economy, with a broad and diverse metropolitan statistical area. While the city has failed to address a pension funding plan, Emanuel has halted former Mayor Richard Daley's practice of using asset lease reserves to balance the budget and funneled about $45 million back to reserves to bolster the city's existing $550 million permanent reserve.
