“The amount of yield that investors should be willing to concede for such provisions should be limited, no matter what the rating uplift,” wrote Lisa Washburn of Municipal Market Analytics.

CHICAGO – Illinois legislation to establish a new borrowing program for home rule governments may look good on the surface, but won't necessarily protect investors against a borrower's general creditworthiness.

That's the assessment from Municipal Market Analytics, which reviewed the legislation, one of 12 bills in the Illinois Senate's "Grand Bargain" package aimed at solving the state's fiscal crisis.

Under Senate Bill 10, a home rule municipality could enter into an agreement assigning a set amount of revenue it receives from the state to a special entity such as a public corporation or trust-like fund established for the "limited purpose of issuing obligations" for the municipality. That revenue would bypass a municipality's general fund.

Senate backers say the new program would allow home rule municipalities to dedicate tax revenues to secure a lower interest rate for borrowing.

Sources say Chicago is pushing the legislation to leverage its sales tax revenue through a structure insulated from its general obligation ratings, which range from junk to the triple-B category.

"MMA believes that, while SB0010 may provide some positive optics for investors in IL local government debt, it does not mitigate concerns over weak credit fundamentals," wrote author Lisa Washburn, a managing director.

The legislation is vague on execution details, doesn't include language on a statutory lien, and has fewer positive attributes than seemingly similar structures in other states where comparisons have been made, Washburn wrote. Those states include New York, Michigan, and California.

The structure, by making the revenues owned by a special entity, is designed to shield the bonds from the threat of being dragged into a bankruptcy proceeding, and insulate them from a municipality's general credit to obtain better ratings.

MMA counters that the treatment of a bond structure or security can't be known with any certainty ahead of severe distress, citing challenges posed to Detroit water bonds and Puerto Rico's GOs COFINA sales tax-backed bonds.

Detroit's water and sewer bonds were believed by investors to face no risk associated with a city bankruptcy but the city's emergency manager attempted to drag the debt into the city's Chapter 9 case.

"The amount of yield that investors should be willing to concede for such provisions should be limited, no matter what the rating uplift," Washburn wrote. "It should also be taken under advisement that the bill would reasonably provide an incentive to borrow in the face of otherwise politically difficult decisions, which could aggravate the fiscal condition of a struggling municipality."

In bankruptcy, judges have tended to view the payment of debt service as less than an essential core function of the government.

"In this light, MMA is fairly skeptical of the durability of structured finance-ish techniques (as in SB0010) that lack clarity that bondholders are specifically secured by a statutory lien or a special revenue pledge," Washburn wrote.

MMA said the new borrowing program's language falls short of sturdier provisions that have been built into legislation elsewhere.

It does not appear to provide a statewide classification of certain debt types as benefiting from a statutory lien or a state-managed program. While statutory lien don't necessarily protect against a default during bankruptcy, they enhance recovery.

In Rhode Island, the state passed legislation to provide general obligation bondholders with a statutory lien. Due to uncertainty after Detroit's bankruptcy over whether some local California governments' bonds truly benefited from a statutory lien, the state enacted legislation providing clarity.

Michigan's local government borrowing program is managed by a state agency – the Michigan Finance Authority -- under the director of the state officials. In New York, the authority established to help fiscally strained communities access the market also provides oversight of the municipality's finances with a goal of restoring financial stability.

While revenues pledged to bonds that meet the bankruptcy code's definition of "special revenues" can continue to flow to bond repayments in bankruptcy, "whether dedicated ad valorem tax revenues should be treated as special revenues is unsettled and subject to much debate in the industry," MMA added.

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