Chicago’s top-rated sales tax securitization bonds required more leg work and styling to cater to post tax-reform market appetites, market participants said.

On its second outing with the Sales Tax Securitization Corp. credit, the city faced a market environment with higher yields and weaker demand compared to its inaugural sale in December, and its tax-exempt spreads widened as a result, but a one-week delay in the pricing that saw the transaction downsized and the addition of a taxable piece improved its prospects.

“The fact it got pushed meant it wasn’t a slam dunk,” said Matt Fabian, partner at Municipal Market Analytics. “The underwriting seemed to face some hurdles that the first underwriting didn’t.”

The city had planned a nearly $900 million tax-exempt issue last week – a follow-up to the $744 million debut last December – but held the deal citing a tougher “market tone” and investor input that prompted a look at an index-eligible taxable bond.

The city returned with $376 million of tax-exempts that priced Tuesday and $304 million of taxables that priced Wednesday. Goldman Sachs led the syndicate. Proceeds are refunding general obligation bonds.

"I think the city was prudent to wait, given the completely different deals they did this week versus what they proposed last week,” said Brian Battle, director of trading at Performance Trust Capital Partners.

“I think the city was prudent to wait, given the completely different deals they did this week versus what they proposed last week,” said Brian Battle, director of trading at Performance Trust Capital Partners.

On the taxables, Battle described the pricing as fair but noted the roughly 25 basis point rise in Treasuries since December that impacted the yield.

“The nominal difference in rates is swamped by the actual savings of the refundings using the improved credit structure of the STSC,” Battle said. The bonds were rated AA by S&P Global Ratings and AAA by Fitch Ratings and Kroll Bond Rating Agency.

Market participants said more complicated credits like Chicago's face more scrutiny with the December rush in the rear-view mirror.

“It’s a different market from December,” said Dennis Derby, senior research analyst and portfolio manager at Wells Capital Management. “I think the deal did fine and it’s saving them by lowering the interest rate they pay on the GO.”

The taxable tranche saw a spread of 87.5 basis points to Treasuries compared to more than 400 bp on the city’s last taxable GO sale. The tax-exempt spreads of 52 to 61bp to the Municipal Market Data’s top benchmark compare to spreads of more than 300 on the city’s last GO sale.

The tax-exempt piece drew 42 investors, was two times oversubscribed, and generated present value savings of 6.3%, city officials said.

“Despite a changing market environment and ratios, these refunding bonds priced approximately 275 basis points tighter than similar maturities on the city’s most recent general obligation pricing just last year, demonstrating the strength of this credit and ability to achieve significant debt service savings on behalf of taxpayers,” Chicago’s chief financial officer Carole Brown said in a statement.

The city did not immediately release a statement on the taxable pricing.

Yields were up and spreads widened on the tax-exempts, which offered longer maturities compared to the December transaction.

The yield on Tuesday’s 2031 maturity was more than 40 bp higher than the December 2030 maturity, reflecting in part higher prevailing rates in the current market.

The 13-year maturity in 2031 landed at a 53 bp spread to the triple-A. The long $79 million bond in 2048 with a 5% coupon landed at a 60 bp spread to the triple-A. The deal also offered $100 million in a 2048 maturity with a 4% coupon. The spreads are based on the benchmark ahead of the market opening.

Spreads ranged from 52 to 61 basis points, according to the city’s calculations based on the benchmark at the market’s close.

The long 13-year 2030 maturity in the December deal had landed at 2.40%, 24 basis points over the triple-A benchmark and 15 basis points better than the preliminary pricing. The maturities offered 5% coupons and a premium price. The spreads are based on the benchmarks set ahead of the opening on the day of pricing. The December deal priced on a day that yields saw a steep drop as investors snapped up any available supply that day.

The city said spreads on the December sale ranged from 26 bp to 43 bp based on the market close benchmarks, with a 39bp spread on the 2030 bond.

The city headed into a rockier market this year grappling with the temporary government shutdown earlier in the week, Central Bank meetings, and post-tax reform shifts in appetite compared to December when yields were falling and the market consumed any offerings.

On the day before the Dec. 6 pricing, the 10-year closed at 1.99% and was down to 1.88% at market close on the day of pricing. The 10-year closed Monday at 2.14% and was 2.15 % Tuesday.

Derby said overall market interest has been strongest on the short end based on accounts he manages.

Other factors were at play.

“The second series of bonds were longer and investors may have demanded a concession to take on this risk. The second is that this credit is tied closely into the state of Illinois and spreads for IL GOs have increased recently,” said Municipal Market Data strategist Dan Berger. Illinois’ 10-year has widened nine basis points to 185 bp between the December and January deal pricings, he said.

While the city stresses the securitization’s high grade ratings and legal opinions on its bankruptcy-remote structure that’s supposed to insulate it from city fiscal strains, the market imposes a varying penalty for the link.

“I don’t think they saw the demand they thought they would get,” said one trader, citing doubts raised by some market participants who believe the wherewithal of such structures is not known until tested in the courts.

“While there’s more interest on the front end, there’s more risk on the long end,” the trader said.

The $300 million taxable bond that priced Wednesday with a 2048 maturity landed at 3.82%, an 87.5 bp spread to the comparable Treasury bond at 2.945%.

December’s taxable portion didn’t go as far out as Wednesday’s tranche but it did offer a somewhat comparable large taxable term bond for $350 million due in 2043. It priced at an 87.5 bp spread to comparable Treasuries then at 2.75%.

While using a taxable structure expanded candidates for refunding to include advance refundings that can no longer be done as tax-exempts under the federal tax bill, the trade-off is a lack of future flexibility given the make-whole call provisions that limit refunding opportunities. “The city is unable to restructure the bonds for 30 years,” Fabian said.

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