CHICAGO — The Lombard, Ill., village board rejected a request from its public facilities agency to cover a shortfall in the January debt service payment on a portion of nearly $190 million bonds issued for a hotel and conference center in the village.

While reserves will be tapped as they have in recent years, the village's decision could result in the first payment default for the project's Series B bonds which carry the village's appropriation pledge, market participants warned.

The bonds were part of a complex debt package issued in 2005 to finance construction of the hotel and conference center located west of Chicago.

Ahead of the board's vote last Thursday, one market participant tracking the bonds' status for investor clients warned the village of the potentially far reaching impact of its actions, calling any refusal to honor an appropriation pledge a "very much a major event in the municipal bond market."

The letter was sent by Joseph Patire, senior vice president, investments, at SP Financial Group of Raymond James, to Lombard's finance director, Tim Sexton, on Dec. 16.

Sexton did not return calls to comment on the letter or potential payment default on the Series B bonds.

The Lombard Public Facilities Corp., which owns the struggling complex, made the appropriation request as it has done for the last several years at the village board's meeting late last week. The board has repeatedly rejected the request leaving the agency to tap reserves to cover the Series A and B bonds. Payment defaults have continued to accrue on the subordinated C bonds.

Reserves are running low on the Series B bonds and there's potentially a $700,000 shortfall on the January payment depending on revenues available from the hotel and conference center and reserves, according to market participants. The Series B reserve holds about $287,000.

For the bonds' July payment, the Lombard agency drew $1.6 million from A reserves and $588,000 from B reserves while the nearly $2 million debt service payment on the third tier C bonds went unpaid. The agency drew a total of $1.5 million from reserves to cover debt-service payments owed last January on the A and B bonds.

An ad-hoc committee established by the village as well as administrative staff recommended against approving the appropriation at Thursday's board meeting and the board followed their recommendation.

"We have continued to consistently recommend that the village board not put additional tax payer dollars toward a payment shortfall," said village trustee Peter Breen, who stressed that taxpayers will not face any additional fees or taxes as a result of the vote. "Our hotel and conference center are staying open and we don't anticipate any changes … the issue is merely debt related."

The ad-hoc group did recommend that the village hire additional advisors to provide future guidance on the issue.

The affluent village has already paid a steep credit price for its decisions on the bonds and could face further penalties following an actual default on the appropriation-backed B bonds. Standard & Poor's previously cut the village's issuer credit rating down to BBB from AA.

The village last year pulled a $10 million new-money issue of certificates from the market when investors took a pass on the debt which was secured by any legally available and appropriated funds but lacked the firmer full faith and credit pledge.

Use of the GO pledge is limited by property tax caps for the non-home rule village. Earlier this 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.

The Lombard Public Facilities Corp. issued the hotel and conference debt in three series in 2005. Under terms of a tax rebate agreement, the village pledges — subject to appropriation — to cover debt-service shortfalls on $118 million of series A bonds before a formal reserve is tapped.

The backstop was triggered with the January 2012 payment shortfall. The village's decision not to honor its limited commitment prompted the steep cut in its Standard & Poor's GO rating. LPFC bonds rated by the agency are below investment grade.

The Series B bonds for $43 million carry a more direct appropriation pledge but reserves are tapped first before the village is asked to cover shortfalls. The $23 million of C bonds are subordinated.

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.

Patire warned in his letter of the market ramifications of a "no" vote.

"I have worked in this industry for over 15 years, and have studied many decades more of municipal bond data, and I cannot 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."

Patire questioned why the ad-hoc committee would not recommend honoring the appropriation to avoid a payment default given its modest size relative to the village's "significant" resources and warned the village of what he believes is a short-sighted action.

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, and keep it there for a very long period of time," he wrote, adding that a potential legal challenge could also loom.

The Series A bonds earlier this year traded at 67 cents on the dollar while the Series B bonds traded earlier this month at 36 cents on the dollar. The facilities corp.'s financial filings showed as of Sept. 30, reserves on the A bonds totaled $3.8 million, with special first and second tier reserves holding $2.5 million and the Series B reserve down to $287,000.

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