CHICAGO — Chicago's plan to add $200 million in debt to cancel 15 interest-rate swaps while weaning itself off debt restructurings offers a long-term payoff worth the added pressures on an already strained balance sheet, says chief financial officer Lois Scott.
The $200 million is the cost of cancelling and paying off swaps tied to its floating rate general obligation and sales tax paper because of negative mark-to-market valuations. The city plans to convert a total of $900 million of variable-rate debt to fixed rates. It will also trim by $75 million the amount of general obligation bond principal being pushed off in 2016 for budgetary relief.
The measures are among a series of mostly debt-related steps Mayor Rahm Emanuel plans as he heads into a second term with his city facing battered credit ratings, a $400 million structural budget gap, and looming $550 million spike in its next budget for public safety pension payments.
The proposals won't do anything to solve the city's most pressing threat to its credit rating and solvency — the $19 billion of unfunded pension liabilities. Still, city officials are hoping analysts and the market — where city paper is trading at speculative grade levels — will look favorably on the changes.
"I think they would be positively disposed to the steps we are taking because they are the right things to right the ship financially," Emanuel said in an address to Chicago Civic Federation Wednesday.
While some market participants said the steps could appeal to investors and rating agencies, Emanuel's ongoing failure to address the need for new revenues left Eric Friedland, portfolio manager at Schroders Investment Management, unimpressed. "They are still not addressing the revenue side," Friedland said. "With every announcement they have the opportunity to address it."
The debt management won't solve the city's need for an infusion of new tax revenue to stabilize its finances, Friedland said.
Matt Fabian, partner at Municipal Market Analytics, called the changes small with little "material bearing" on the city's "enormous financial challenges," but said they mark a first step in the right direction aimed the right audience --rating agencies and investors. "They need to take charge of the narrative and at least appear proactive in instilling fiscal discipline," Fabian said. "The changes hit on hot button points the city has taken a beating on." Questions about scoop-and-toss and swaps have become a distraction from Chicago's need to deal with its core pension problems, Fabian said.
The maneuvers also stand to benefit the city by reducing its dependence on banks for credit support and solve a potentially embarrassing swaps dilemma that leaves the city at the mercy of bank counterparties as its GO credit ratings slide, a slide that has already triggered swap termination events.
It's been a long four years of "managing complex financial challenges" on three fronts — pensions, operating costs, and debt — Scott said in an interview after Emanuel outlined the policy measures.
Scott said the time is ripe to now "double up" on efforts to shed some of the city's riskier debt structures inherited from the administration of Mayor Richard Daley and to ease up on tactics, begun by Daley but continued by Emanuel, of using debt for budgetary relief.
"I think this is the right long-term financial strategy for the city," Scott said.
Emanuel vowed to phase out by 2019 the practice of pushing off some principal payments. The city won't quit cold turkey on the tactic as it faces mounting fiscal pressures, but it will trim by $75 million the roughly $240 million it planned to restructure in 2016.
The city embarked on the so-called "scoop and toss" practice beginning in 2007 when it pushed back repayment of $50 million. The figure has increased as the city sought to smooth out and hold steady its escalating debt service schedule on $8.3 billion of GO debt. The city pushed off $170 million in 2014 and $200 million in the current budget.
The city also will set aside more in its operating budget to cover operating expenses from legal settlements and judgments, reducing the amount that is put on its long-term debt tab. The city said it could not yet say how much or by what percentage that figure might be reduced.
The city will accelerate its ongoing conversion of GO-backed floating rate debt, moving about $800 million from four series to a fixed-rate structure and canceling swaps attached to three of those tranches. One sales tax series for $116 million will also be converted and one swap cancelled.
"They are the right steps" for the financial well-being of the city, Emanuel told members of the Civic Federation, a government research organization that has chided the city for some of its debt practices.
Swaps associated with the GOs carry a negative valuation of $162 million. A swap tied to the sales tax deal carries a negative valuation of $29 million. Scott said the city would tap is commercial paper line to make the cancellation payments and then roll the expense into long term debt in a GO sale expected later this year.
Scott defended the plan saying the swap costs are "already a long-term debt" that is being paid off now.
The measure will solve the city's dilemma over three swaps with counterparty Wells Fargo Bank in which termination events were triggered by its February downgrade by Moody's Investors Service to Baa2.
Wells granted the city a forbearance staving off a demand for payments of about $40 million but has resisted city pressure to lower the rating threshold at which a termination event occurs. A termination event on a fourth swap was also triggered by the downgrade but counterparty BMO Harris Bank previously agreed to lower the threshold to below Baa2, allowing the city to avoid $20 million payment.
Scott said the city has little wiggle room, given the contract terms, to negotiate with its counterparties on the valuation that will determine cancellation payments.
Several market participants said renegotiating the rating thresholds on trigger events represented a better solution, but given Wells refusal to budge on the swap terminations already triggered, the city needed a solution, and rolling the cancellation payments into long term debt eases near-term pressures.
The steps will allow the city to eliminate rollover risks when letters of credit and other liquidity support expire. Fewer banks offer such support and the city's credit slide makes bank support more costly.
The swap cancellations would also ease worries should the city's credit ratings tumble any further — a prospect that looms should an adverse Illinois Supreme Court come this spring on state pension system reforms.
Depending on the extent of the ruling, existing reforms to two of the city's four pension funds could be impacted and it could impact negotiations with police and firefighter unions on a reform package for them, which would also require state legislative action.
Two additional swaps face termination triggers if the city's GO rating is lowered by one more notch by Moody's.
The city expects to complete the reoffering of two series of floating-rate paper in the coming weeks. They include a 2002 series with Ramirez & Co. as lead manager and a 2003 series led by Siebert Brandford & Shank & Co., Scott said. The city will return possibly in the third quarter to convert a 2005 and 2007 series. The city has swaps tied to the 2003, 2005, and 2007 series. The sales tax conversion will come later as the city must update that credit's financials.
The administration has sought to highlight strides in managing its swap portfolio and bank risks over Emanuel's first term. Officials have terminated seven swap or swap options on $1 billion of floating-rate debt and struck more favorable terms on termination triggers on 12 derivatives tied to $1.3 billion of debt since 2011. It also had banned entering new swaps. On its LOCs, the city has sought to diversify its bank exposure and struck more favorable rating terms on new LOCs.
In announcing the debt-related measures, Emanuel is taking aim at practices attacked by his critics during the recent mayoral election and criticized by many market participants as shoddy fiscal tactics employed by distressed issuers. Emanuel acknowledged Wednesday that they "mask the true costs of government."
The city has not offered up a plan to cover its budgetary shortfall or higher pension payments because it is pinning its hopes on state legislative support for police and fire pension reforms that would include relief from the contribution spike, which would begin funding public safety pension on an actuarial basis.
City officials have said a property tax hike is a last resort, but investors believe the city has little choice as pressures mount. Civic Federation president Laurence Msall said it's not a question of whether the city will need to raise taxes, but by how much.
"The city is in a difficult financial position," Msall said after the address, adding "we think these are very good and positive steps."
Despite the steps announced Wednesday, the city remains far from out of the woods on its credit risks. In addition to GO bond swaps, it has derivatives tied to its Midway Airport, water and wastewater enterprise revenue credits with rating triggers in the triple-B category. The city is leaving alone debt tied to those enterprise funds at this time. They carry a negative valuation of about $200 million.
Three second-lien water swaps have triggers at below the Baa1 level. Moody's recently affirmed the credit's A3 rating.
Three second-lien wastewater swaps are tied to a $332 million issue from 2008, including two with triggers below the Baa1 level. Moody's recently downgraded the second lien wastewater credit to Baa1, meaning another downgrade would trigger the termination events.
While it's shedding exposure on its GO portfolio, the city has a total of 26 liquidity support, letter of credit, and direct purchase facilities with rating thresholds for events of default on most triggered at a speculative grade rating, according to a disclosure published in March. The city's plan to convert its GO floating rate debt will eliminate 12 of those support features. Four bank support contracts totaling $372 million that are tied to the city's wastewater credit and O'Hare International Airport have a threshold below the BBB level.
The city's lowest wastewater bond rating is A3 from Moody's on junior-lien revenue bonds. Its lowest underlying rating for third-tier O'Hare airport revenue bonds is A-minus from Fitch Ratings.
A default under the city's revolving lines of credit at a speculative grade rating would allow the termination of its credit facilities, requiring the city to immediately pay all outstanding amounts. The city earlier this year said it has $294 million outstanding under its short term borrowing program with a capacity of $900 million.
Standard & Poor's rates the city's GOs A-plus and warned a downgrade will come if the city doesn't make headway this year on a pension fix and budget pressures. Fitch Ratings and Kroll Bond Rating Agency rate them A-minus. All but Kroll assign a negative outlook. Kroll assigns a stable outlook.
