Harvey, Illinois, finally seals deal ending litigation over bond default

Five years almost to the day since bondholders sued Harvey, Illinois, over a payment default, the litigation concluded Tuesday with court approval of a settlement that features fresh, unrated debt with extra protections for investors and a friendlier debt payment schedule for the long-struggling Chicago suburb.

The private settlement between investors and the city provides a "unique opportunity to resolve this case, which has been pending for a significant period of time," said Cook County Circuit Court Judge Michael Mullen at a Tuesday morning hearing before signing off on the settlement and an accompanying motion to dismiss.

"Everybody has worked incredibly hard and earned a big gold star for persistence," Mullen said. "You've all stuck with this and zealously represented your clients, so very well done."

Fioretti for Cook campaign

Bondholder attorney Brent Vincent thanked the judge. "It was absolutely essential that we had the court's assistance on this," Vincent, a partner at Bryan Cave LLP, told the court.

The settlement was approved after the city Aug. 22 closed a tender exchange offer with bondholders, who swapped out old defaulted debt for restructured 2023 paper with an extended maturity date and direct intercept. Nearly 95% of bondholders participated in the exchange.

The settlement ends a saga dating to 2016 when Harvey began to miss its debt payments on general obligation bonds issued in 2002 and 2007 that totaled around $32 million.

On Sept. 4, 2018, Invesco Rochester Municipal Opportunities Fund and Susquehanna Government Products, LLLP, who owned just under $17 million of the 2007 bonds, took legal steps to try to force the city to make good on its payments. The lawsuit also named Cook County officials for failing to send tax dollars directly into an escrow as required under the ordinance authorizing the 2007 bonds.

The default underscored the fiscal stress facing the city of less than 20,000 23 miles south of Chicago. The declining tax base and an anemic collection rate has long failed to support the city's debts.

That's sparked litigation from the city's largest debt holders, including bondholders, public safety pension funds — which city officials warned could have led to bankruptcy — and the city of Chicago over delinquent payments for treated Lake Michigan water.

Harvey also has been slapped in the past with Securities and Exchange Commission sanctions. The lawsuit with Chicago over the water is still pending, with the parties disagreeing over the amount owed.

Tuesday's court settlement terminates a 2020 consent decree between bondholders and the city that siphoned off 10% of Harvey's revenues, and removes the city's general obligation debt from default status.

"It's a huge step for Harvey," said Robert Fioretti, of Fioretti Campbell LLC, which has long represented Harvey in litigation.

"This takes the bonds out of default; we've paid off the police pension at this point and they're funded; we're paying down the fire pension," Fioretti said. "Things are going very well for Harvey right now."

Its most recent audit, of fiscal 2021, posted on the Municipal Securities Rulemaking Board's EMMA bond disclosure website on April 28, shows the city continues to face fiscal pressure. That includes an accumulated unassigned general fund deficit of $62 million as of April 30, 2021, as well as high operating and legacy costs and a declining tax base, the audit warned. "If the city is unable to make improvements in these areas, the city's financial status could deteriorate further and its options to improve its fiscal health may be limited," the audit warned.

The bond exchange that cleared the way for the court settlement was launched in July. The financing included $27.8 million of unrated limited-tax general obligation bonds and $6.3 million of taxable, limited-tax GO bonds.

The new bonds include a tax levy with a direct intercept and the appointment of a bond trustee. The old bonds had no trustee, and the appointment of UMB Bank NA — the main trustee for distressed municipal debt — brings in an entity that could fund future litigation or deal with defaults if necessary.

The settlement and exchange does not include bond insurer Assured Guaranty, which covered payments on a chunk of insured 2002 bonds and has sought repayment from the city by intervening in the bondholder litigation.

The 2020 consent decree allocated a levy to Assured that's separate from the bondholders' levy. Attorneys for Assured did not appear at Tuesday's hearing despite notices, a minor "hang up" that shouldn't affect the final settlement, said bondholder attorney Vincent.

The new bond indenture calls for Harvey to levy a direct annual tax from 2022 to 2052 of up to $4.5 million to repay the bonds. The pledged revenue would flow directly to bondholders under a tax intercept escrow agreement between the Cook County collector, city, and trustee. Excess property tax revenues will be used to redeem the bonds in order of maturity, according to bond documents.

Coverage on the new bonds is thin at only one times, due to an assumed collection rate of 42.5%.

The city's actual property tax collection rate for the last three years has hovered around 56%, according to bond documents. The bonds are also payable from any other available revenue sources.

The city will enjoy a friendlier debt schedule on the new debt as maturities are pushed out 20 years and interest rates are lower.

The schedule on the 2023 bonds calls for payments totaling $1.732 million until fiscal 2025 when they rise to $1.99 million, where they stay through 2053.

The 2007 bonds carried interest rates of 5.5%, 5.65% and 7.75%, and the 2002 bonds had rates from 5.4% to 5.6%. The 2007 bonds were rated BBB-minus by Fitch Ratings at issuance, according to an official statement posted on EMMA; the 2002 bonds were unrated.

The 2023 debt carries rates of 4%, 4.5% on the tax-exempt Series A and 5% on the taxable Series B bonds.

The largest tranche of the Series A bonds, $25.2 million, is a term bond due in 2054. A $700,000 tranche is due on Sept. 15, and a $1.87 million term bond is due in 2028.

A small taxable piece is also due on Sept. 15 while the bulk of the series is a term bond due in 2035.

After years of being stuck with defaulted debt, bondholders are hoping the new paper will be more liquid. The bonds have not traded since the exchange.

Tuesday's motion calls for the case to be dismissed without prejudice, a move that gives the court jurisdiction to enforce terms to ensure Harvey hits milestones over a certain period of time. After hitting that "magical date," Mullen said, the court would dismiss the case permanently.