OREANDA-NEWS. Fitch Ratings has assigned an 'AA' rating to the following city of Chicago (the city) bonds:

--$85 million second lien wastewater transmission revenue bonds, series 2015 (taxable).

The bonds are expected to sell via negotiation the week of October 12.

In addition, Fitch affirms the following ratings:

--$1.5 billion second lien wastewater revenue bonds series 2004B, 2006A, 2006B, 2008A, 2010A, 2010B, 2012, 2014 (all fixed rate) and variable-rate series 2008C-1, 2008C-2, 2008C-3 at 'AA'.

The rating is removed from Rating Watch Negative and assigned a Negative Outlook.

At the sane time as the sale of the 2015 bonds, the city will reoffer the series 2008C bonds at fixed interest rates with proceeds to pay the purchase price of the 2008C-1, 2008C2, and 2008C-3 bonds mandatorily tendered. Proceeds of the 2015 taxable bonds will be used to refund certain lines of credit issued to fund swap-termination payments related to the 2008C bonds, provide capitalized interest, and pay issuance costs.

Fitch rates the water system's senior and second lien bonds 'AA+' and 'AA', respectively, both of which are on Rating Watch Negative for similar reasons as the wastewater system bonds. The water system bonds are under review and Fitch expects to resolve the Rating Watch in the near term.

SECURITY
The bonds are secured by net revenues of the city's sewer system (the system) after the payment of operations and maintenance expenses and debt service on the senior lien bonds (not rated by Fitch).

KEY RATING DRIVERS

NARROWER MARGINS DRIVE NEGATIVE OUTLOOK: The Negative Outlook reflects concerns over rising forecasted costs and weaker debt service coverage (DSC) than previously expected. Projections have been revised downward in recent years in large part because of direct and indirect pension cost estimates.

SHORT-TERM LIQUIDITY RISKS ABATED: The removal from the Negative Watch reflects the city's successful renegotiation of financing agreements, which removed the liquidity risks posed by the system's variable-rate debt and swaps exposure. The current issuance and re-offering will result in a debt profile consisting 100% of fixed-rate debt.

STRONG FINANCES AND OPERATIONS: The system's financial performance has been strong recently, the result of solid fiscal management and the adoption of a multi-year rate package. Operations are restricted to collection and transmission only, limiting operating risks and capital pressures.

INDEPENDENT RATE-SETTING, AFFORDABLE RATES: City council has full and complete authority to set rates. Customer charges remain affordable despite rates that have doubled over the past four years. Inflation-adjusted increases going forward provide some baseline revenue growth for the system.

MANAGEABLE DEBT BURDEN AND CIP: The capital improvement plan (CIP) anticipates funding roughly one-third of the $1.6 billion in proposed spending from internal sources. The debt burden is expected to rise but remain manageable with metrics rising above the medians for the 'AA' category, but still well below the levels demonstrated by most comparably-rated urban systems.

SIZABLE SERVICE AREA: The city serves as the economic engine for the region with a broad and diverse employment base and solid underlying economic fundamentals.

RATING SENSITIVITIES
FURTHER OPERATING PRESSURES: Failure to meet financial projections and/or additional forecast incremental erosion in system key metrics, including particularly DSC, would likely lead to a downgrade of the credit.

DEVELOPMENTS AFFECTING SYSTEM: The current rating paradigm, which is based on system operations, could shift depending on future actions by the city as well as from continuing pressure on the city's general credit quality. Specifically, diversion or increased likelihood of diversion of system resources to support non-system purposes or expenses would be expected to lead to negative rating action.

CREDIT PROFILE

STRONG FINANCES BUT NEGATIVE OUTLOOK ON RISING COST PRESSURES
The system's financial profile has improved following full implementation of a multi-year rate plan that increased operating revenues by nearly $149 million from fiscal 2011-2015 (projected). Strong revenue performance, coupled with limited operating expense growth has boosted the system's margins and free cash flow (FCF), leading to a more robust liquidity position and financial capacity to address aging infrastructure.

DSC, which was just 1.1x on an all-in basis in fiscal 2011, reached a very solid 1.9x in fiscal 2014. FCF has improved from very weak levels to over 2x annual depreciation in fiscals 2013 and 2014. Especially noteworthy is the improved cash position; unrestricted cash and investment balances reached $111 million in fiscal 2014, or 340 days cash on hand. Including the rate stabilization fund, liquidity is in excess of 400 days of operations.

Financial results projected for fiscal 2015 show further improvement in financial metrics with all-in DSC reaching 2.1x in light of a 19% rate increase for the year. Despite the favorable 2015 figures, margins in subsequent years have been revised downward, primarily from rising operating expenses and debt service costs. In particular, indirect costs related to city general fund reimbursements for services rendered to the system are expected to jump more than 30% in 2016 taking into consideration associated police and fire pension ramp-up costs during the year.

The city currently projects that total DSC (net of transfers to the rate stabilization fund) will dip to 1.8x and 1.7x in 2016 and 2017, respectively. While these coverage levels are still strong, they fall short of recent projections of over 2x total DSC. DSC may come under additional pressure if operating costs continue to escalate at a pace beyond the inflation-adjusted automatic rate hikes already approved for 2016 and beyond. Also, the current pace of additional debt, if realized, would likely pressure financial performance beyond the current forecast. Additional deterioration in financial expectations would be expected to result in negative rating action in the future.

TANGENTIAL RISK FROM CITY FINANCIAL PRESSURES REMAIN
The city's unlimited tax general obligation rating of 'BBB+'/Negative Outlook reflects significant underfunding of pensions along with an ongoing structural deficit which Fitch expects will put tremendous fiscal strain on the city's general fund. On the positive side, the mayor's proposed 2016 budget identifies the resources needed to meet the expected phased-in increases in required pension payments, including a sizable increase in ad valorem taxes and other fees. However, several challenges remain, including legislation allowing for the phase-in for police and fire pensions that has yet to be signed into law and resolution of pension reform for the municipal and laborers pensions that has been overturned by a lower court and is being appealed to the state Supreme Court.

While Fitch views the potential for spillover of financial pressures to the city's utility funds as unlikely beyond expected rising indirect costs, signs or indications of such spillover could be expected to result in negative rating action. Fitch believes severe liquidity stress within the non-enterprise funds (including the general fund) would likely pose the greatest threat to the utility. Consequently, diversion of utility monies for non-utility purposes (e.g. transfers out, borrowable resources); a shifting of non-utility costs to the system (e.g. increased headcount); and/or other potential indicators of possible stress that might lead the city to divert system resources (e.g. slowed capital spending to preserve cash) would be considered a significant departure from prudent system management and counter to Fitch's current expectations and rating approach.

COLLECTION-ONLY SYSTEM WITH LIMITED OPERATING RISK
The system provides collection and conveyance services to approximately 2.8 million city residents. The system is mainly gravity-fed and almost exclusively consists of small-and large-diameter sewer mains and laterals. All wastewater treatment is provided separately by the Metropolitan Water Reclamation District of Greater Chicago (GO bonds rated 'AAA' by Fitch), significantly limiting the system's operating risk profile and potential for costly regulatory issues.

DEBT BURDEN MANAGEABLE, LARGE CAPITAL PLAN
The system's 2015-2019 CIP is a sizable $1.6 billion but expected to continue to fund necessary sewer renewal and improvement projects for long-term system sustainability. Rates were prudently raised to provide adequate funding for the program, which will consist of additional debt but also increases the amount of pay-as-you-go resources. In total, the city expects to issue approximately $900 million in additional debt over the next four years (2016-2019). This more balanced approach to capital funding is viewed positively by Fitch as previous CIP's were almost exclusively debt-financed.

The city has been more aggressive in funding system capital needs over the past five years. Since fiscal 2010, the city has spent roughly $150 million annually on infrastructure improvements leading to a reduced average age of plant, but to increased system leverage. As of fiscal 2014, the system had $1.7 billion in total debt outstanding consisting mainly of second lien bonds.

Despite the rise in leverage, the debt profile remains manageable. Debt totaled an affordable $646 per capita in fiscal 2014 and carrying costs comprised roughly 30% of gross revenues. Debt-to-net plant was an elevated 86% in fiscal 2014, although much of the system's capital assets have long been fully depreciated. The debt burden is expected to rise as the city continues to fund its CIP, although Fitch does not anticipate the additional debt will greatly change the system's moderate overall debt profile.

BROAD AND DIVERSE SERVICE AREA ECONOMY
The city's economy is the economic engine for the state and serves as a regional employment hub for the mid-west. The economy is exceptionally broad and diverse, with significant business and financial service sectors and a well-educated work force. The unemployment rate for the entire Chicago metropolitan area has improved to 6% in June 2015, from 7.1% one year prior, due to a combination of employment growth and a slight drop in labor participation. The unemployment rate remains slightly above state and national averages.