CHICAGO - With a hard-won sales tax increase in hand, Cook County, Ill., plans to enter the market tomorrow with $150 million of tax anticipation notes in a deal that marks the county's first market trip to raise new money under the administration of Todd Stroger and his hand-picked finance chief.
Proceeds from the note sale will supplement the county's operating cash until sales tax revenue begins to flow into government coffers later this year. The transaction comes a week after the county implemented a controversial 1% sales tax increase that pushed Chicago's sales tax to 10.25% - the highest in the nation.
The deal is the county's first since Donna Dunning took over as chief financial officer in March 2007. Formerly the county's budget director, Dunning replaced longtime CFO Thomas Glaser when Stroger, who is Dunning's cousin, became county board president. Stroger replaced his father, John Stroger, who ran the county government for 12 years until he suffered a stroke and later passed away.
The county has refunded pieces of its $3 billion general obligation debt over the last few years, but the note sale represents its first large new-money sale since 2004. It's also the county's first cash flow note sale in several years - a sign of financial distress according to some rating analysts.
With a population of 5.3 million and an annual budget of more than $3 billion, Cook County has a large and diverse tax base and is funded largely through property tax and sales tax revenue. By raising the county's portion of the regional sales tax to 1.75% from 0.75%, officials expect to bring in an additional $420 million annually.
The county board approved the tax hike in February after a protracted political battle, and it went into effect July 1. The county will not begin to collect the money until October or November, and needed to issue the notes to bridge the gap, Dunning said in a recent interview.
In preparing for the note sale, Dunning and other top county officials assembled a team that puts two Wall Street firms in the lead spots with two minority-owned firms rounding out the syndicate. Four firms will take on advisory roles.
Top county officials, including John Daley, chairman of the finance committee, also met with the three rating agencies for the first time in nearly two years, laying out strategies for overcoming their chief fiscal and political pressures. In addition to chronic deficits and a growing structural deficit, Stroger has faced fierce political challenges from some county commissioners and others who criticize the administration on everything from its fiscal decisions to what critics call "family and friends" hiring policies.
Citing some of the county's fiscal pressures, Fitch Ratings last week revised its outlook to negative from stable on the county's $3 billion in outstanding general obligation debt. Fitch affirmed its AA rating on the county's GO debt and assigned an F1-plus, its highest short-term rating, to the notes.
Moody's Investors Serviceand Standard & Poor's also assigned their highest short-term rating to the notes, MIG-1 and SP-1-plus respectively. Moody's affirmed the county's Aa2 GO rating with a stable outlook. Standard & Poor's rates the county's AA with a stable outlook.
The $150 million in sales tax anticipation notes, expected to sell tomorrow, are general obligations of the county. The notes mature Aug. 2009. Under the county ordinance authorizing the sale, the county will set aside part - about one-tenth - of its sales tax revenues received from the state each month into a note fund. The anticipated $626 million in sales tax revenue expected to flow to county coffers between October 2008 and July 2009 provides 4.1 times debt service coverage, noted Standard & Poor's.
Morgan Stanley is senior manager on the deal, and Merrill Lynch & Co. is senior co-manager. Also on the underwriting team are Grigsby & Associates Inc. and Ramirez & Co. Bond counsel is Chapman and CutlerLLP and underwriter's counsel is Pugh, Jones, Johnson & Quandt PC. Financial advisers include Robert W. Baird & Co., Mesirow FinancialInc., and Peralta Garcia Solutions LLC, all of Chicago, and Bagley Financial Corp. of Detroit. John Daley's nephew William Daley Jr. is a public finance banker at Morgan Stanley, but the county is not one of his clients and county board approval was not needed for the deal's finance team.
Dunning said the county selected the firms based on their experience with short-term issuances and familiarity with Cook's operations.
"All of our investment bankers are coming to me with ideas all the time, but the make up of this team reflects an expertise in the area of issuance of sales tax anticipation notes for larger governmental agencies, as well as their knowledge of the county and county operations," she said.
In pushing for the sales tax increase, county officials said the money would cover a roughly $250 million deficit, as well as shore up its ongoing structural deficit. But the $400 million in additional annual money could be insufficient to wipe out the government's structural deficit, and the county will have to seek out more revenue sources, Dunning warned in a speech earlier this year.
"The sales tax increase doesn't solve all of the county's problems at all," Fitch analyst Melanie Shaker said,noting that the county's 2007 revenue expectations from cigarette taxes and patient collections also proved too optimistic. In some ways, the tax hike introduces some new short- and long-term risks for the county as well as Chicago and the surrounding suburbs.
The short-term risk, as Fitch sees it, would come if sales tax revenues fell short of expectations amid a deteriorating economy - a risk the county itself recognizes in its official documents accompanying the transaction. The long-term risk includes the loss of businesses and residents who leave the county - as well as Chicago and the county suburbs - to avoid paying the highest sales tax in the U.S.
"It's going to continue to build up over time," Fitch analyst Peter Stettler said of the impact of the high sales tax. "The city doesn't grow as fast, the county doesn't grow as fast, and it does restrict financial flexibility as well."
On the political front, the Stroger administration's ability to push through the sales tax increase - a measure that nearly shut down the government as the board was unable to reach a budget resolution by the end of the 2007 fiscal year - bodes well for the county's overall fiscal profile, said analysts.
"It's helpful to be able to make hard decisions and $400 million is a big boost," said Moody's analyst Edward Damutz, adding the county will need to take additional steps to close its structural imbalance. "You can conceivably burn through that [$400 million] pretty quickly if the basics of a structural balance are not met. With further workforce reductions, other performance-based measures, reduced expenditures and efficiencies, we were able to view the county as stable at this point in time."
For Fitch, the county's move to issue cash-flow notes is itself a sign of financial pressure, as are pending bond issues over the next few years. Later this year, the county expects to issue $105 million in pension obligation bonds to cover a 2007 payment.
Dunning said the pension bond issue is needed due to decisions made by the former CFO and former comptroller. The county also expects to issue up to $240 million in so-called self-insurance bonds over the next one to three years in order to cover claims and liabilities that as of 2006 have been paid out of its general fund.
Another future challenge will come as most of the collective bargaining contracts covering the county's 21,000 employees expire on Nov. 30, 2008.
Analysts praised a recent move by the county to overhaul its massive and troubled bureau of health, one of its long-time key fiscal problems. With three hospitals and 13 clinics, the health bureau annual budget is $850 million, a third of the county's total budget.
Over the last few years, as the health system has racked up deficits that reached $70 million in fiscal 2007, several state leaders, including U.S. Sen. Dick Durbin, D-Ill., urged the board to hand control over to an independent board of medical and financial executives.
Stroger agreed to the plan as part of a final budget compromise that included approval of the sales tax increase, and in June the board formally handed over day-to-day operational control to an 11-member board.
The board will soon pick a new chief executive officer and chief financial officer, and the county will continue to approve the system's annual budget. As part of the move, the system was renamed the Cook County Health and Hospitals System.
"They're starting to address some of their issues," Moody's Damutz said.