State revolving fund key to Chicago's water project financing plans

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CHICAGO – Chicago is planning an up to $400 million water revenue refunding early next year and will tap into the state’s low cost revolving loan program for up to $450 million in the coming years to fund new capital projects for water.

The Chicago City Council Finance Committee signed off on the plans during a meeting Monday and the full council is expected to authorize the borrowing at its Wednesday meeting.

Mesirow Financial is the lead on the advance refunding. The city declined to comment on the potential impact on its borrowing plans should the House Republicans' proposed tax bill, which eliminates tax code provisions that allow for one advance refunding of bonds, become law.

The city is planning over multiple years to tap into loans administered by the Illinois Environmental Protection Agency, said finance department spokeswoman Molly Poppe.

The roughly 1.7% rate on the state loans is “much lower than what we would get by doing long-term bonds,” chief financial officer Carole Brown said during the committee hearing.

The city’s water revenue bonds are rated between the triple-B and double-A. The city last issued water revenue bonds in June. The 10-year in the deal paid a yield of 2.88%, 105 basis points over the Municipal Market Data’s AAA benchmark that day, 87 basis points over the AA, and 52 basis points over the BBB.

The Illinois Finance Authority, which issues the triple-A rated state revolving fund bonds, sold $560 million over the summer with its 10-year maturities landing at 2.11% and 2.17%, about a 25 bp to 30 bp spread over the AAA benchmark, which is typical of Illinois-based issuers.

The bond proceeds help fund loans to finance eligible wastewater treatment and sanitary sewerage facilities and drinking water facilities. The IFA has ramped up its state revolving fund issues to fund loans to local governments due to demand for financing to overhaul aging infrastructure.

Ahead of the city’s June sale, Fitch Ratings dropped its ratings by one notch moving the second lien to AA-minus and the senior lien to AA. Fitch assigned a negative outlook based on weakening financials.

Fitch said it’s concerned “that the system's growing fixed-cost burden, led by the onset of higher pension-related costs and rising debt service, will weaken the system's currently strong financial profile over time.”

Another factor in Fitch’s concerns is the potential impact of a water/sewer surcharge the City Council approved last year as part of Mayor Rahm Emanuel’s overhaul to stave off the threatened insolvency of the city’s municipal employees' pension fund.

The utility surcharge, based on consumption, layers on costs to utility customers that do not provide a direct benefit to the utility or its bondholders, Fitch said. The total bill for city residents, while currently affordable, will increase by approximately 32% over the next four years.

“Fitch is concerned the increase in taxes, rates and fees across the entire spectrum of city services, may lead to rate fatigue,” analysts wrote.

Emanuel won phased in, double-digit water and sewer rate increases to accelerate capital spending soon after taking office in 2011 and since 2016 rate hikes are tied to the consumer price index. Rates will rise 1.83% this year and 1.5% next year.

The city is dipping into the water/sewer system revenues as permitted to help cover rising pension payments for employees working in those systems and the city has yet to identify future additional revenue sources to cover a big jump in payments expected in the next few years.

The city has $2.47 billion of water revenue bonds almost all issued under the second lien. Coverage of 2.19 times is expected this year but falls to 1.81 times in 2019, compared to a 1.10 times requirement.

The city’s 10-year water infrastructure program calls for spending $2 billion through 2021 to upgrade 880 miles of 100-year-old water mains, install meters, and upgrade steam powered pumping stations and two water treatment facilities.

“Approved rate increases and expense control, both for operating and capital expenses, should help support the rating at its current level,” S&P Global Ratings said of the water credit in June. S&P rates the second lien A and the senior lien A-plus, with a stable outlook.

The second lien carries a AA rating and stable outlook from Kroll Bond Rating Agency, with a stable outlook.

Moody’s Investors Service is no longer asked to rate the city’s water bonds but it rates existing second lien Baa2 and the senior lien Baa1 and affirmed the ratings in September. It assigns a negative outlook.

“The ratings consider the water and sewer enterprises' vulnerabilities to credit pressure on the city of Chicago (Ba1 negative) given tight governance and management linkages and overlapping service areas that cover a tax base heavily burdened by debt and pensions,” Moody’s wrote.

The city supplies Lake Michigan water to roughly city 494,000 accounts as well as 125 suburban communities for a total population of approximately 5.3 million.

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Primary bond market Revenue bonds Infrastructure Refunding bonds City of Chicago, IL Illinois