CHICAGO — Four months after Mayor Rahm Emanuel’s administration announced it was exploring a $10 billion pension obligation, the deal
Emanuel, who is not seeking a third term in the February municipal election, outlined a structure for issuing $7.7 billion of securitization bonds and $2.3 billion of special water-sewer excise tax bonds during a speech Wednesday. Unless the council moves quickly, it will fall to his successor who takes office in May to decide whether to proceed.
Emanuel also offered other revenue and reform measures, all of which require state action, to chip away at the city’s $28 billion unfunded pension liability, raise its 26.5% funded ratio to more than 50%, and lower contributions spikes of $275 million coming due in 2020 and $310 million in 2022.
A handful of the 21 candidates vying to succeed Emanuel panned the borrowing. Aldermen were leery of its long-term impact on the city’s finances. Investors, analysts, and watchdogs offered mixed reviews that ranged from skepticism to cautious optimism.
“I think the mayor deserves credit for continuing to raise this critical issue,” and the series of proposals that includes support for a constitutional amendment allowing for some benefit cuts as well as raising new revenue by legalizing recreational marijuana and building a Chicago casino “really shows the magnitude of what’s needed for a solution,” said Laurence Msall, president of the fiscal watchdog Chicago Civic Federation, which still has serious questions about a pension bond borrowing.
“There’s a lot more of details we need to know and stress testing” that takes into account potential market fluctuations, Msall said. “We would like to see a lot more detail before putting the taxpayers at risk.”
There are definite cons that would go with the potential pros of a big POB deal, said John Humphrey, head of credit research at Gurtin Municipal Bond Management.
“If that is the goal, simply to smooth the ramping up to annually actuarial funding, I guess it would likely be a success because the benefits will be gotten right away, but it will cost $10 billion, still leave you with a 50% funded system, and the debt service associated with the POBs,” he said.
“Mayor Emanuel has done a very good job shoring up the city’s short term problems during his tenure, and also was the first one to face head on the problem of the pensions, and his attempts now, solidify our view that, while some of the proposals being made carry risk and uncertainty, it speaks more to just how large the pension problem is in that there are no good answers, than as a failure in the mayor,” Humphrey said.
"The truth is, there is risk in every choice and there is a risk if you do nothing," Emanuel told the city council Wednesday.
“The projected savings in a pension bond transaction come exactly because the city is taking on additional risk,” said Matt Fabian, partner at Municipal Market Analytics.
“Chicago’s fiscal future needs less risk, not more. A POB sale of this size would mean the city might finally merit its below-investment grade rating,” he said.
“Maybe it works out, but if it doesn’t both the city and the pension fiscal situation will be worse for it,” said Lisa Washburn, a managing director at MMA.
THE PITCH
The administration would dump all pension obligation bond proceeds into the retirement funds, a move that would bring the funded ratio up to at least 50% from 26.5%, and shave $6 billion to $7 billion off future city contributions needed to reach a 90% funded ratio over the next four decades, assuming the funds get the expected investment return on the money. It would lower the spike coming due when actuarially required contributions must be made because to the funds.
The city is aiming to borrow in the 5% to 6% range because of the higher ratings its securitization and revenue bonds enjoy over its weak GO. It pays at least 7% on the unfunded liability based on the funds’ current discount rates.
The $7.7 billion securitization would lockbox the city’s city share of state income tax collections, personal property replacement taxes, and residual sales tax revenues not needed to repay its sales tax securitization bonds.
The $2.3 billion of Water and Sewer Excise Tax Receipt revenue would be secured by the tax that was levied in 2016 to fund the ramp up in contributions to the municipal fund.
The city collected $148.3 million in PPRT taxes in 2017, or 4% of corporate fund revenues. It received $239.9 million from its local share of income taxes which accounted for 6.5% of corporate fund resources. The residual sales taxes pledged to the sales tax securitization but not needed for debt service totaled $150.8 million last year, according to the city’s 2018
THE DEBATE
Issues raised by market participants in recent months, including market risks all remain in play. Treasury rates rose over the fall but have since fallen while the stock market remains volatile.
Some investors worry about diverting more revenue to back bonds and fear it will damage the value of existing general obligation bonds while others share the city’s view that GO values would improve from a more stable pension system.
Past POB issues have contributed to issuers’ later fiscal distress and there’s disagreement over whether shifting a portion of the cost for pensions to a hard debt liability from a softer one is desirable.
The Government Finance Officers Associations recommends against issuing pension bonds.
Three institutional investors who hold the city’s GOs and sales tax securitization bonds and attended the announcement said they were “cautiously optimistic” but still have questions about the borrowing, whether the revenue proposals will come to fruition, and the path Emanuel’s successor will take. The three asked not to be identified.
“Bonding out pension liabilities in and of itself is never a stand-alone solution but it can be a piece of a broader more comprehensive solution as long as it’s viewed as a piece of the puzzle,” said one investor, praising the city for its past efforts at reform shot down by the courts and passage of new taxes to fund higher contributions.
“If we were to see an administration come in and not have the same level of fiscal discipline that could be problematic over the long term,” said one investor.
While locking up revenues for the securitization may be viewed as a drawback, “if it improves the overall credit profile of the city, that’s also something to consider,” said one.
Although he sees the point raised by the three investors, Howard Cure still worries about peeling off revenue that flows to the corporate fund and locking it up for securitization bondholders. “From a holistic point they are probably right but from an isolated investor view point that is not necessarily right,” said Cure, director of municipal research at Evercore Wealth Management, LLC.
And the risks weigh on his opinion.
“You are taking a risk in a volatile equity market. Are they hitting it at the right time?” Cure asked. If they miss their mark, it’s a long road to recover and the city is stuck with a fixed bonded debt cost.
“It’s not a complete package," Cure said. "There’s nothing on the expenditure side.”
Chicago Chief Financial Officer Carole Brown argues that a POB simply swaps one debt for another, lower-cost one. Some believe that limits flexibility, but the three investors said that may not be such a bad change.
“You can take a pension holiday but you can’t take a principal and interest payment holiday…moving it over has risks and advantages but there are benefits” because it imposes fiscal discipline on future leaders, said one investor.
Richard Ciccarone, president of Merritt Research Services, sees the case for imposing discipline with a hard liability, but worries over how it limits fiscal flexibility going forward.
“You are taking on more risk,” he said. “My judgment is reserved on this as there’s a lot of moving pieces.”
Like others, Ciccarone said praised the mayor for focusing attention on pensions. “We can’t afford to sit still,” he said.
COUNCIL AND CANDIDATES
Council members will have to weigh whether the long-term risks of borrowing are worth the upfront gains.
“Avoiding the tough issue to pay down this pension by issuing bonds is nothing more than a pension holiday,” said Alderman George Cardenas.
“The devil is in the details on pension bonds. I have many, many questions about whether pension bond funding is an appropriate way forward,” said Alderman Michele Smith, who believes an independent financial appraisal is needed.
Alderman Scott Waguespack is skeptical, citing comments from S&P in its budget review over risks to the city’s rating and volatility of the stock market which all could be “potentially painful for our taxpayers.” He wants the council to leave the issue to the next mayor.
Even those aldermen who said they are open to borrowing said the proposal requires a deep review.
Many in the passel of mayoral candidates back Emanuel's idea to use revenue from legalized marijuana and a casino to bolster pension funding, but criticize of other pieces of his plan.
“We can’t go back on a promise that was made to retirees and pensioners,” said state Comptroller Susana Mendoza in opposition to the amendment. “I support a progressive income tax, legalizing marijuana, will fight for a Chicago casino and will evaluate other available tools to ensure we are doing everything we can to shore up our pensions, stabilize our finances and properly invest in education.”
Bill Daley, who served in President Obama and President Clinton’s administrations and is the brother of former Mayor Richard M. Daley, was one of the few who left the door open to an amendment, saying everything must be on the table to deal to avoid burdening property taxpayers.
Former Chicago Public Schools school board president and lawyer Gery Chico said he’s put aside his skepticism of the borrowing plan from earlier this year after discussing it with fiscal professionals.
Cook County Board President Toni Preckwinkle’s campaign did not respond to a request for comment.
Another candidate, former alderman Bob Fioretti, labeled the proposals “impractical, impossible, not serious.” Even if a constitutional amendment made it to the ballot and passed, he argues it won’t allow for cuts to retiree and current employee benefits and labor has vowed a legal fight.
Former CPS executive director Paul Vallas, who was a vocal critic of the pension bond idea from the start, attacked the proposals. “Constitutional amendments and casino revenues will both require protracted efforts with completely unclear outcomes and cannot be counted on as a foundation for reform. And we all know that a pension obligation bond is just kicking the can down the road.”
The governor-elect let the air out of the idea of a state constitutional amendment to tackle pension benefits.
“I just don’t see the likelihood of anybody getting a constitutional amendment passed to change that provision in our constitution, and it’s not something I’m out promoting in any way,” J.B. Pritzker said.
That could change once the governor gets into office and has a better understanding of the enormity of the problem at the state and local government level, Msall said.
Pritzker has touted legalization of marijuana as a revenue source and a new gambling expansion bill will introduced to the legislature early next year.
