Chicago Tests Bond-Market Alchemy With Debut of AAA Rated Debt

(Bloomberg) -- Chicago will start selling as much as $575 million of investment-grade-rated debt that’s backed by a dedicated share of sales-tax revenue it receives from Illinois, insulating bondholders from the city’s financial strains.

The offering is the first by the Sales Tax Securitization Corp., which was created after Illinois enacted a budget this year that allows municipalities to sell debt backed by state funds they received. That added security allowed the bonds to receive an AAA grade by Fitch Ratings, nine steps higher than Chicago’s general obligations.

The bonds, which will price as early as Tuesday, are the first in Chicago’s plan to refinance as much as $3 billion of debt through the corporation. That will save the city an estimated $94 million, according to city documents.

“The corporation is a separate corporate existence and is bankruptcy remote from the city,” Carole Brown, Chicago’s chief financial officer and the president of the corporation, said in a roadshow presentation to investors.

That’s reflected in the view of credit-rating companies. S&P Global Ratings deems the securities AA, the third-highest rating and five levels higher than the city’s general-obligation bonds. Fitch considers the bonds AAA, even though it rates Chicago’s general obligations one step above junk. Moody’s Investors Service, which has already dropped the city one step below investment-grade, wasn’t asked to rate the new bonds.

What Analysts Say:

  • Conning: This kind of borrowing is a "smart" move by city leaders, according to Paul Mansour, head of municipal research at Conning, which oversees about $9 billion of state and local debt, and is considering buying the deal. “This makes a lot of sense because you’re not taking money out of the system. The residual revenues will flow back to the city. You’re just creating a better credit that lowers interest rates overall for the city and therefore in and of itself is a good thing,” Mansour said.
  • Wells Fargo Asset Management: The deal should “come tighter” than the G.O. bonds, said Dennis Derby, a portfolio manager at Wells Fargo Asset Management, which holds $41 billion of municipal debt, including Chicago’s. “It’s checking off all the boxes that bondholders want,” he said, adding that the firm is considering buying. “They want a separate and secured revenue stream, less exposure to the general-obligation credit and strong coverage mechanisms.”
  • Gurtin Municipal Bond Management: Even though it looks like the city went out of its way to protect bondholders “as best they could,” the firm still isn’t buying, said John Humphrey, the Chicago-based head of credit research for Gurtin, which oversees about $10.1 billion of state and local debt. “It’s an untested model," he said. In "bankruptcy while not allowed today, it’s still unclear how this would be treated."

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