CHICAGO – Chicago Mayor Rahm Emanuel’s administration is still weighing whether to proceed with a $10 billion pension bond issue, a decision complicated by the mayor’s announcement that he won’t seek re-election next year.
“The mayor’s announcement on Tuesday added another variable to the decision-making process and we are still in the process of making a final decision,” Chicago’s chief financial officer, Carole Brown, said in an interview Monday amid rising skepticism from market participants over whether the city will proceed.
The city is still evaluating how to execute a transaction with the “right structure” and address questions that would be posed by the market and aldermen, she said.
Brown previously said she expected to make a recommendation to Emanuel early this month. “I have had conversations with the mayor and senior staff and I have more questions I have to answer,” Brown said. It’s more of an ongoing discussion now, she said.
The mayor’s looming exit has sparked market concerns about the city’s future fiscal direction. Some believe the political uncertainty could curb appetite for the pension deal and drive up borrowing rates, making it harder for a POB deal to pencil out.
“Fiscal policies put in place by the Emanuel administration could be at risk with new leadership,” Nuveen Investments head of municipals John Miller wrote Monday in the firm's weekly fixed-income commentary. Emanuel raised a series of taxes to cover rising pension contributions. A “political willingness to raise revenues again, especially soon after the mayoral and city council election, is a key risk to Chicago credit,” Miller wrote.
Brown's comments suggest if a deal is properly structured targeted savings could still be achieved despite Emanuel’s decision.
The pension idea was first pitched by mayoral advisor Michael Sacks during the city's August investors’ conference. Brown later told reporters she was reviewing the idea as a means to raise funded ratios to more than 50% from 26.5% and ease the size of looming contribution spikes by bringing down the $28 billion net pension liability.
Emanuel said in an interview late last week on WBEZ radio that the option remains on the table. “It has to make financial sense – meaning securing people's pensions – and not whacking our taxpayers any more than they need to be – and they shouldn't be,” he said.
If Chicago opts to move forward, the buyside will not see a broader plan that includes labor concessions and new revenue to more fully stabilize the pension system.
“I am not anticipating today that we would come with a package that included all the revenues we needed” to fully meet the pension funding schedule that puts all the funds on track to reach a 90% funded ratio by 2058, Brown said.
“From what we are hearing from market participants,” Brown said, the announcement “hasn’t really changed where they think an appropriately structured transaction would go out at.”
MARKET SIGNALS
Chicago bonds' secondary market yields fluctuated last week after the mayor’s announcement.
“I think if we proceeded the goal is to show demonstrable savings” over the current discount rate in the 7% range the city pays on its unfunded liabilities, Brown said. The city is banking on a rate on the taxable paper in the 5% to 6% range.
While Emanuel’s decision not to run weighs on the evaluation process, other factors have not changed, Brown said. “We always knew we had to raise new revenue [in the future] and that doesn’t change,” she said. “My No. 1 goal [in looking at a pension issue] was to lower the cost for taxpayers of our pension debt and to do it in a responsible way.”
The city would use the proceeds of any deal solely to pay down the unfunded liability. Brown anticipates a schedule of level debt service repayment and that the proceeds would likely be distributed in a manner that gets all four funds to more than 50% funded. The current ratios range from a low of 20.1% to a high of 48.3%.
“I think it’s clear we would be using the debt to stabilize the funds and to lower part of the unfunded liability, not to forgo contributions” as the state did with $2.7 billion of its $10 billion 2003 pension obligation bond sale, Brown said.
The infusion of cash would reduce the $28 billion net pension liability, which in turn would lower the upcoming contribution spike needed to reach an actuarial based payment.
When the ARC requirement hits in the 2020 for police and fire funds, contributions jump by $280 million. The spike hits for municipal and laborers' funds in 2022 when payments rise by $310 million.
“As far as I can tell you either have to have a significant tax increase or a significant cut in public safety, a significant cut in basic government services like garbage collection and other things. I've rejected those two. I'm trying to present an alternative third option,” Emanuel said.
Brown said she has not had any formal discussions with rating agencies, but sources said the city or its banking advisors have shared preliminary information.
A potential deal would likely use the city’s securitization structure – which carries double-A to triple-A ratings – or some revenue structure that would garner higher ratings than the city’s general obligation credit, which has a junk Ba1 rating from Moody's, triple-B category ratings from S&P Global Ratings and Fitch Ratings, and an A from Kroll Bond Rating Agency. A GO is off the table, Brown said.
If the city proceeds, Brown said, the aim is still to get into the market with a single deal this year. “I have a higher degree of confidence we can get the rate we need in this market,” she said.
If a deal comes to fruition – and it would the largest ever from a local government – it would top a crowded city slate for this year that includes a roughly $1.5 billion airport sale, a $750 million Sales Tax Securitization Corp. deal, and $900 million of water and sewer borrowing.
Brown isn’t worried about oversaturation. Volume has picked up but it’s still short of demand and underwriters are telling her given the depth and size of the corporate market it could absorb the pension issue.
“I just don’t think it would be a problem," she said.
THE MARKET
“There is a confluence of factors” that would cause headwinds for a deal, said Richard Ciccarone, president of Merritt Research Services LLC. “There’s political uncertainty which is tied to the city’s credit future because the market views Rahm Emanuel as at least having attempted to provide support for the city’s credit position,” as well as interest rate risks.
The policymaking Federal Open Market Committee is expected raise the federal funds rate later this month and could again act in December, analysts say.
A rise in city borrowing rates would threaten the savings anticipated by lowering the pension liability. The arbitrage risk is already a primary concern among POB critics.
While spreads widened on some city general obligation paper after Emanuel’s
Mid-week a taxable 2042 bond traded wider by 20 basis points at 316 over comparable Treasuries, said IHS Markit strategist Ed Lee.
Several taxable bonds traded Wednesday at five points wider. Chicago’s taxables held on Thursday with a 2042 bond trading at a yield of 5.42%, 320 bp over Treasuries. “Chicago paper rebounded a bit, tightening five bps as buyers emerged,” IHS said in its Friday commentary. A 2040 bond traded at 338 bp over Treasuries.
On the tax-exempt side Wednesday, a 2040 tax-exempt bond traded at 137 basis points over the MMD top rated benchmark compared to a previous spread of 150bp. A 2033 bond traded at 133, versus a previous trade of 163 and a 2036 bonds traded at 134 compared to a previous spread of 156, Lee said.
Market participants were hard-pressed to come up with a specific reason why some bonds narrowed.
“The initial impression was that these bonds would have spreads that would widen with this announcement. However, after the initial trepidation the market in these bonds has tightened” by about 10-15bps, MMD strategist Dan Berger said Sept. 5.
“It might not be credit related. It could be a technical thing. Perhaps high-yield buyers are seeking an opportunity and think that this is a good way to capture yield,” Berger said.
“There may be a belief that the pension bonds are now less likely,” Ciccarone said. That perception could be viewed positively for the value of existing GOs that some believe are damaged because the city siphons off revenues from its corporate fund to back the securitization structure.
Another trader said it too early to tell what last week’s spread movement means. “It’s tough to say until we have more clarity” on the city’s decision on pension borrowing and on how the mayoral race shapes up, the trader said. “That’s the time to watch where spreads move.”
Municipal Market Analytics sees “some upside” for city creditors and taxpayers if Emanuel shelves a possible deal and while the administration stresses its commitment to solely issuing POBs to bring up funded ratios, MMA worries that the next mayor may have less “scruples" about taking contribution holidays or other budget financing gimmicks up front.
ALDERMEN
A POB deal already faced deep scrutiny from the City Council as well as mayoral and aldermanic challengers.
“While we are continuing to ask for the transparency and open discussions that are needed, and not just one meeting, I think it still gets passed as a legacy thing for Rahm,” said Alderman Scott Waguespack, Progressive Caucus chair.
“It's an opportunity for opposition candidates on the aldermanic side to pressure their alderman to do their homework,” Waguespack said. “I don't suspect many will listen. Despite the problems I bet it passes with little opposition. I'm hoping that's not the case and working on other aldermen to vet it more seriously.”
Brown met recently with aldermen. A handout suggested a $10 billion deal – labeled by the city as fund stabilization bonds – could generate more than $6 billion in long-term savings for the city.
Waguespack late last week sent Brown a letter with his list of questions he wants answered before any vote on POBs.
“For years, we have argued that new, progressive revenue sources are needed, and this proposal will not negate that need … what is the mayor’s plan to create new revenue sources to cover the new debt service this alone will generate?” he asked.
Other questions included: What is the target annual interest rate? What refinancing provisions will the administration seek? If the market goes into a recession within the first years of the deal, what is the plan to fund the city's debt?
The city will be investing proceeds at market highs with some warning of a future downturn.
“This is the largest bond deal on the municipal level in recent memory and will double the city's debt service; what do you expect the market appetite will be for something this large? Will the council will have the ability to review and either approve or deny the potential securitization of the issuance?” he asked.
