Fitch Rates City of Chicago, Illinois's $124MM Wastewater Second Lien Revs 'AA-'.

CHICAGO -- Fitch has assigned a 'AA-' rating to the City of Chicago, Illinois' $60 million second lien wastewater transmission revenue bonds, series 2006A, and $64 million second lien wastewater transmission revenue refunding bonds, series 2006B. The Rating Outlook is Stable.

The 'AA-' is affirmed on about $522 million of outstanding second lien wastewater transmission bonds. The bonds are expected to price on November 8 through a syndicate led by Morgan Stanley. The 2006A bonds will finance capital improvements and extensions to the wastewater transmission system; the 2006B bonds will current refund first lien series 1995 bonds and advance refund series 1998B, 2000 and 2001A second lien bonds. The bonds are limited obligations of the city payable solely from net available second lien bond revenues from the city's ownership and operation of the wastewater transmission system. Deposits in the second lien construction accounts also secure the bonds issues. These bond series are subordinate to the city's senior lien bonds and any other senior lien parity bonds.

The 'AA-' rating reflects steady system demand, low customer rates, a flexible capital program due to few regulatory compliance issues and adequate debt service coverage. Although the system collects sanitary sewage and storm water run-off for the City of Chicago, the Metropolitan Water Reclamation District of Greater Chicago (rated 'AAA' by Fitch) is solely responsible for sewage treatment, disposal and flood control. The department of water management separately manages water and sewer operations for the city and is expected to realize efficiencies following the merger of two separate departments in 2003. User fees are among the lowest in the country, reflecting the narrow scope of responsibilities, the gravity-based nature of the system and a steady program of capital replacement. As a home rule municipality, Chicago independently sets its sewer rates through city council ordinance. Although combined debt service coverage of senior and second lien bonds declined to just 1x in fiscal 2003 (December 31 year-end), reduced personnel costs and steady sewer service rate increases led to stronger debt service coverage of 1.09x in 2004 and 1.60x in 2005 (against earlier projections of 1.01x in 2004 and 1.14x in 2005). Anticipating 3% spending in growth and no rate changes, combined coverage is projected to be 1.10x in 2006 and 1x in 2007 and 2008.

All sewer revenues are maintained as separate city accounts. After meeting the sewer system's operating and maintenance costs, the revenues meet debt service on the senior lien bonds, debt service reserve on the senior lien bonds, debt service on the second lien bonds, debt service on subordinate lien obligations and the sewer rate stabilization account. The debt service reserve account for the second lien bonds, established by a surety bond, will equal the least of maximum annual debt service, 10% of outstanding principal or 1.25 times (x) the average annual debt service requirement. The second lien rate covenant requires net system revenues to cover combined debt service on senior lien and second lien bonds by at least 1.0x. Additional bonds require net system revenues in the last completed year to cover aggregate senior and second lien debt service at least 1.0x, adjusted for the annualized effect of any sewer rate increases enacted for future years.

The wastewater transmission system serves a population of 2.9 million. Metered customers now represent 34% of all customer accounts, following a 1982 city ordinance requiring water meters on new construction. Despite exemptions granted to governmental and not-for-profit organizations (11% of total accounts), the number of sewer accounts have increased 0.7% annually in the last five years. Residential customers, representing about two-thirds of system revenues, have very few billing delinquencies due to joint billing with water charges and the city's aggressive pursuit of delinquencies.

The Chicago wastewater transmission system has few operational duties as wastewater treatment is provided by the Metropolitan Water Reclamation District of Greater Chicago. Because the system's sole purpose is to convey wastewater to the facility for treatment, the transmission system's capital plan is modest and its needs are manageable. The system consists of almost 4,400 miles of sewer lines and, though the system is primarily gravity-driven, three fully automated sewage lift stations situated in areas where gravity flow is not possible. About half of the system's transmission lines have been in service since 1920 and the city replaces approximately 10 miles of transmission mains annually.

The system's 2006-2010 capital improvement plan totals $251.1 million, with external borrowing representing the primary financing source. Projects include flood abatement, sewer replacement, and auxiliary outlet sewer construction. About 85% of the plan is dedicated to sewer replacement and construction, with the balance targeted toward transmission line rehabilitation. Sewer projects are systematically prioritized and the city has identified the most critical areas of need, completing those earlier in the plan. As a result of this planning, the structure of the capital plan is flexible. The system is fully in compliance with all environmental regulations. With no mandated improvements and the good condition of existing infrastructure, the city has some discretion about the plan's timing and execution. Debt to net plant increased to 69% in 2005, from 55% in 1999, but is still manageable. With 70 days of available cash on hand in 2005, sewer system financial liquidity is adequate.

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