CHICAGO - Lombard, Ill. faces the possible loss of its investment grade ratings for failing to honor its appropriation commitments to a hotel project that hasn't worked out exactly as expected.
The village of about 43,000 20 miles west of Chicago refused to cover a Jan. 1 shortfall, resulting in a payment default on a village support piece of $190 million of Lombard Public Facilities Corp. hotel conference center bonds.
The village board voted in late December against appropriating funds to cover debt service shortfalls on the deal's $118 million of A series and $43 million of B series bonds.
Sufficient reserves allowed the full payment to be made on the A bonds which have limited village support under a tax abatement agreement.
The decision on the B bonds, supported by a more direct appropriation pledge from the village, resulted in the first payment default on that series Jan. 1, according to a notice of default published by bond trustee Amalgamated Bank of Chicago.
The elected board that governs the affluent suburb voted against appropriating funds despite a warning from a market participant that such action on the Series B bonds could damage its credit and hurt the credibility of appropriation and moral obligation pledges.
"We have continued to consistently recommend that the village board not put additional taxpayer dollars toward a payment shortfall," village trustee Peter Breen said during the board meeting ahead of the vote. "Our hotel and conference center are staying open and we don't anticipate any changes the issue is merely debt related."
Standard & Poor's placed the village's BBB issuer credit rating and BBB-minus rating on its debt certificates on CreditWatch with negative implications. "The refusal to fund debt service for the series 2005B bonds will likely result in a default of the payment scheduled for the series 2005B bonds on Jan. 1, 2014," said Standard & Poor's credit analyst John Kenward.
The hotel complex has consistently failed to generate sufficient revenues to repay its debt.
With project revenues continuing to fall short, the Lombard Public Facilities Corp. used $964,000 from reserves to make the A series debt service payment and drained the B series reserve of its $293,000 to make a partial payment on the B bonds. A total of $280,000 in principal and $393,000 of interest went unpaid on the B series, according to the notice.
No part of the $2.3 million payment on $29 million of subordinated Series C bonds was made; they don't carry any village support.
Standard & Poor's lowered its rating on the B series to D from CC last week.
"Under Standard & Poor's recently published criteria for general obligation debt issued by U.S. local governments, a demonstrated lack of willingness to support a debt, capital lease obligation, or moral obligation pledge results in a rating cap of 'BBB-minus' or lower for the issuer credit rating," Standard & Poor's wrote. "The extent of the ICR change will take into account information to be obtained from the village during the course of the review." Action on the watchlist is expected in the next few months.
Lombard's finance director, Tim Sexton, said village trustees have taken the position that taxpayers shouldn't have to shoulder the burden of subsidizing hotel revenues over the long term.
"The village is looking for a long-term solution," Sexton said, acknowledging the toll the position has taken on the village's credit. "We continue to work with the bond insurer and other parties to try to resolve this situation."
The village's certificates carry the lowest investment grade level ranking and a two-notch downgrade would sink the village's issuer credit rating into junk bond territory.
Several other Midwestern cities have lost their investment grade credit over refusing to make good on appropriation, moral obligation, or lease supported pledges that helped sell investors on the debt.
Moody's Investors Service and Standard & Poor's punished Vadnais Heights, Minn. in 2012 by dropping its once solid double-A ratings to junk after it decided to cancel its lease and halt financial support for the struggling Vadnais Sports Complex. The lease payments supported repayment of $25 million of revenue bonds.
Moberly, Mo. lost its single-A-level investment-grade rating after it declined to make good on its appropriation pledge supporting $39 million of revenue bonds issued for an artificial plant being built by Mamtek US Inc. The company abandoned the half-built plant and the bond issue has come under local, state and federal regulatory scrutiny.
Lombard's decision is all the more striking to market participants because of its sound fiscal position, said Richard Ciccarone, president of Merritt Research Services LLC. The village carried a 48% fund balance in fiscal 2012 and low debt levels, suggesting it has the resources to cover the shortfall, at least temporarily. The village maintains a 25% general fund balance and also carries a utility fund balance, Sexton said.
"To renege on a commitment to make good on a bond promise strikes at the heart of the fiscal credibility of Lombard," Ciccarone said, adding it "casts a shadow on other general fund appropriation or moral obligation promises less secured than a general obligation pledge."
The Lombard issue also provides another example of the risks of investing in non-essential governmental projects where there's less incentive for a government to step up when needed.
One market participant tracking the bonds for investor clients sent a letter to the village ahead of the board vote that its action would mark "a major event in the municipal bond market."
Joseph Patire, senior vice president, investments, at SP Financial Group of Raymond James, said he could not "recall a time when a municipality with the significant financial means Lombard possesses willfully chose to disregard its obligation to creditors who, in good faith, loaned money with the reasonable and rational expectation that village trustees would uphold their pledge and moral obligations as promised in the bond indentures."
He also cautioned the village on the long term consequences of its actions. "Credits are rated on two criteria: your ability to pay, and your willingness to pay .it is extremely likely rating agencies would move to lower the village's credit rating deeply into junk territory," he wrote, also warning of a potential legal challenge.
Sexton reiterated the village trustees' position that a long-term solution is needed that doesn't burden taxpayers with a big subsidy tab. The village has already paid a steep credit price and struggled for market access due to decisions on the hotel debt. Standard & Poor's previously cut the village's issuer credit rating to BBB from AA.
The village last year pulled a $10 million new-money issue of certificates when investors took a pass on the non GO debt secured by any legally available and appropriated funds. Use of the GO pledge is limited by property tax caps for the non-home rule village.
Last year the village opted to invest in municipal bonds to secure a $10 million commercial bank loan as an alternative method of raising funds for infrastructure work. Sexton said proceeds would cover the village's infrastructure needs through 2015 so near-term market access is not needed.
The Lombard Public Facilities Corp. issued the hotel and conference debt in 2005. Under terms of a tax rebate agreement, the village pledges — subject to appropriation — to cover debt-service shortfalls on the A bonds before a formal reserve is tapped. The backstop was triggered with the January 2012 payment shortfall. The B series carry a more direct appropriation pledge but reserves are tapped first before the village is asked to cover shortfalls.
A proposed tender of the Series A and C bonds at a loss failed in 2011.
Nuveen Investments is the majority holder. The project includes an 18-story, 500-room hotel operated by Westin Hotels & Resorts, a 55,500-square-foot convention center and two restaurants. If the project were to declare bankruptcy, the Series A and B bondholders have a mortgage claim.
The Series A bonds last year were trading at 67 cents on the dollar while the Series B bonds traded last month at 34 cents on the dollar. About $2.9 million remains in reserves on the A bonds, a portion of which carry insurance from ACA Financial Guaranty Corp.