CHICAGO – Tucked into the Illinois Senate's sweeping "Grand Bargain" budget legislation is a bill to authorize a new type of local government bond that would benefit Chicago and other home rule communities.
Senate Bill 10 of the 12-bill package "allows home rule municipalities to dedicate tax revenues for bonds in order to secure a lower interest rate for borrowing," according to a Senate description distributed to lawmakers. "The ability to borrow at lower interest rates will help local governments save money."
It compares the program's structure to the state's sales tax-backed Build Illinois bond program that has at least partially escaped the credit and pricing deterioration of the state's general obligation bonds.
Several market participants view the legislation favorably.
"Striving to enhance a security for a bond issue has to be considered a positive endeavor," said Richard Ciccarone, president of Merritt Research Services.
Under the legislation, a home rule municipality could enter into an agreement assigning a set amount of revenue it receives from the state to a special entity such as a public corporation or trust-like fund established for the "limited purpose of issuing obligations" for the municipality. The dedicated revenue would bypass a municipality's general fund.
For example, the home rule municipality and an issuing entity would enter an assignment agreement for, say 0.25% of that municipality's share of sales tax revenues. The home rule municipality would need to approve the agreement by ordinance. Bonds would be sold and all revenue from the 0.25% of dedicated sales tax revenues would go directly to special purpose entity for bond repayment.
The structure, by making the revenues owned by a special entity, is designed to shield the bonds from the threat of being dragged into a bankruptcy proceeding, and insulate them from a municipality's general credit to obtain better ratings.
"It provides another mechanism of structured financing for a municipality which is intended to remove any bankruptcy risks as other states have provided," said James Spiotto, a municipal restructuring expert and co-publisher of MuniNet Guide. "This type of securitization-like structure has had the effect of providing greater liquidity and better credit acceptance so you can reduce borrowing costs."
Chicago supports the legislation.
"SB10 gives home rule units in Illinois the ability to use a similar structure that the state uses for its own revenue bonds, allowing the city to create stronger security provisions for our revenue bond debt," said finance department spokeswoman Molly Poppe. "We have not finalized any plans for future borrowing" should the bill become law, she said.
Chicago paid punishing spreads of between 339 to 347 basis points over the Municipal Market Data's triple-A benchmark on its last general obligation sale in January.
Its airport and water revenue backed deals have fared much better.
Revenue streams that municipalities could tap under the proposal include their share of personal property replacement taxes, gambling, sales tax, local government distributive fund revenue, and motor fuel tax revenues.
Use of the latter would require adherence to a recently approved constitutional amendment that restricts the use of transportation-related tax revenues to transportation projects.
Chicago has issued bonds backed by motor fuel revenues and sales taxes, but their ratings have been hurt by connections with the declining ratings of the city and state governments.
The new borrowing program could help improve the ratings of future bonds tapping those revenue streams. Sources said Chicago has pressed for the legislation in hopes of establishing a special sales tax corporation aimed at leveraging its sales taxes without the taint of the city's GO rating.
The release of dedicated revenues under the assignment agreement would not be subject to a state appropriation so it appears that they would be insulated from risks during times when the state doesn't have a budget in place.
Special appropriations have been required to free up Chicago's motor fuel revenues and Metropolitan Pier and Exposition Authority tax revenues collected by the state during the 19-month-old budget stalemate, prompting rating agencies to lower those ratings due to the state association.
Spiotto described the new mechanism as a "variation on a trend you are seeing nationally and a concept that has worked in other states" to help "municipalities provide financing at the lowest possible costs with the least amount of concern over bankruptcy."
The risk is factored into pricing even though Illinois law does not allow local governments to file Chapter 9. Gov. Bruce Rauner, a Republican, and some fellow GOP lawmakers have proposed such a statute but Democrats who control the General Assembly are opposed.
Variations are in place in California, New York, and Rhode Island. It's also a similar concept to Michigan's state aid-backed bonds. Revenues used to repay debt issued under the program flow to the Michigan Finance Authority, not the municipality.
Though Detroit's underlying ratings remain in junk-bond territory, bonds backed by distributable state aid that has sold through the MFA's local government loan program before and after the city's Chapter 9 carry single-A to double-A ratings.
The Illinois legislation doesn't mention a statutory lien but it does offer a "limited and targeted approach to deal with funds coming from the state and to be used through another issuing body or entity," Spiotto said. The central strength of the new borrowing mechanism is the feature that ''irrevocably transfers the dedicated revenues to the special issuing entity until the bond obligations are repaid."
The legislation includes language making clear that the state is not a guarantor of any debt or obligation subject to an assignment agreement.
Backers compare the new mechanism to the state's Build Illinois bonds, which are secured by a percentage of sales taxes, but there are structural differences.
Build Illinois bonds are secured by a first priority pledge of the state portion of the sales tax as well as a lien on the moneys in the fund that receives monthly transfers of the sales tax receipts. The enabling legislation includes strong non-impairment language wherein the state pledges that it will not limit or alter the basis on which the sales taxes are collected and transferred to a special account.
The statutory lien on revenues, strong debt service coverage, and the strong non-impairment language insulate the bonds from state operations and support a rating level that is higher than that of the state's GO bonds, Fitch Ratings wrote in a report last year.
The three major rating agencies all have Illinois GOs at the BBB level.
Fitch assigns its AA-plus ratings to the Build Illinois bonds, while S&P Global Ratings rates them AAA.
Moody's keeps them on par with the GOs at Baa2.
On an August Build Illinois sale, the state saw a spread of 48 basis points over the MMD's triple-A benchmark.
That compares to the 193 bp spread on the 10-year in its October GO sale. Illinois governments generally face spread penalties of 20 to 30 basis points for their location in a fiscally troubled state and for the lack of a dual tax-exemption, because in-state interest is not exempt from state income taxes.
SB 10 would authorize the new borrowing form in the state's more than 200 home rule communities. Municipalities with more than 25,000 residents receive home rule status and for those under that threshold, voters can approve the designation by referendum.
Other bills in the bipartisan "Grand Bargain" would appropriate spending for the remainder of the fiscal year, raise $6.5 billion in annual taxes, expand gambling, change state employee pensions, temporarily freeze local property taxes, overhaul the state's school funding formulas, and include worker's compensation reforms.
A vote is expected this week.
The package's fate in the House is uncertain; Rauner has praised the Senate's efforts but said the final legislation must adequately meet his policy and governance reform demands to win his support for the tax hikes.
A dispute with the legislature's Democratic majority over those demands has driven the 19-month-old budget impasse.