2GenPen Proposes First Ever ‘Collateralized Municipal Loan Obligation’ of $400M for City of Chicago

2GenPen LLC is looking to raise $400 million for the first ever collateralized municipal loan obligation, or CMLO, named Chicago Rising CMLO Trust, which the firm is hoping to launch this fall, according to co-founders Larry Wadler and Penny Pan.

The CMLO is expected to be a pool of taxable debt from myriad Chicago-based credits, including O’Hare International Airport, the Chicago Transit Authority, the Sales Tax Securitization Corp. and the Chicago Park District, in addition to city-issued water and wastewater bonds.

2GenPen has trademarked the CMLO acronym and has been approaching traditional CLO investors regarding their participation in the deal. In an interview with Octus, formerly Reorg, Wadler lauded the strict covenant requirements in municipal bond deals, such as a rate covenant that would require the borrower to maintain a minimum coverage ratio to provide sufficient funds for debt service payments.

“Everyone we’ve spoken to said: ‘Don’t do Chicago, the politics are brutal,’ and we said that’s exactly why we want to do it,” Wadler said. “If we can’t move the needle in terms of how capital market operations impact Chicago, how are we going to [create stability] in emerging market nations and the sovereign debt space?”

The broadly syndicated loan CLO market is predominantly composed of covenant-light credits, which Wadler argued are unnecessary when working with municipal bonds. In addition, the municipal market has a natural base rate of diversification among the ultimate payors. The suggested collateral pool will be static in nature.

One CLO tranche investor said that he would be intrigued to see if the transaction’s senior tranches will be able to gain a higher rating than Chicago’s outstanding general debt obligation rating.

“I’m curious on how the rating would go,” said the investor. “Chicago is a [lower-rated] credit, but if you tranche it out, would the agencies give you a higher rating on the senior tranche?”

In January, S&P Global Ratings downgraded Chicago’s outstanding general obligation debt to BBB from BBB+, citing “a sizable budgetary imbalance,” while assigning a stable outlook and removing the credit from its CreditWatch. City officials responded to the rating action, saying it “does not accurately reflect the strength of the City’s credit or ability to meet its debt and pension obligations,” Octus reported.

The proposed CLO offering, while different in structure and tax status, is reminiscent of two previous collateralized debt obligations administered by Preston Hollow Community Capital, or PHCC, as reported. In February 2024, PHCC sponsored a $135 million offering in tax-exempt pooled securities Series 2024 Class A certificates issued by the Public Finance Authority, or PFA, via a deal underwritten by JPMorgan and Hilltop Securities.

In 2023, PHCC also administered a PFA deal managed by Wells Fargo and Hilltop Securities consisting of $371 million in tax-exempt Class A and Class B social impact certificates. The 2024 deal was rated Aa2 by Moody’s Ratings, and the 2023 deal was rated Aa1 by Moody’s.

2GenPen was met with reluctance from ratings agencies when it came to assigning a rating to the CMLO, Wadler noted. “Our primary difference is that we’re looking to work directly with the issuers themselves to give them the benefit of the credit arbitrage,” he said, pointing out that the PHCC deals received AA-level ratings for a portfolio of junk-rated munis.

The taxable status of the CMLO can also present an opportunity amid political uncertainty around the fate of the muni tax exemption in the upcoming budget reconciliation, Wadler added. “Nobody knows what the federal government is going to do with the tax exemption, so we’re saying, you’d want to have access to the taxable market now,” he said.

In addition, Wadler said 2GenPen has met with Jill Jaworski, Chicago’s chief financial officer, to discuss the terms of the offering and that “the city is aware of it and has supported it.” The true test, however, will come when 2GenPen puts forth a formal offer to purchase with the city and targeted city issuers, which is “imminent” and as early as late May, Wadler said.

Chicago Rising CMLO Trust is not expected to be the only CMLO. 2GenPen is expecting to issue offers to purchase to several other major issuers it has been in discussions with in the coming weeks and months.

The capital structure that 2GenPen has been using to explore the trust with investors, ratings agencies and other market participants, and the city of Chicago, is displayed below.

Chicago CFO Jaworski did not respond to a request for comment.