CHICAGO – Chicago Mayor Rahm Emanuel’s administration won’t include a $10 billion pension obligation bond issue in his proposed 2019 budget but it remains on the table against a backdrop of rising interest rates that threaten to wipe out potential arbitrage savings.
“The city is still considering issuing fund stabilization bonds to increase the funded ratios of our pension funds and lower the cost of our unfunded liabilities,” Chief Financial Officer Carole Brown said Thursday.
“I honestly think that the mayor’s focus is the budget address next week and getting it passed. After the budget address he will turn to this issue and we might have a decision,” Brown added. “The mayor always wanted to focus first on the budget and then…turn to whether it will still make sense” to do before his term ends.
Several local bankers have said at the current rate levels, the deal no longer works.
Brown insisted Thursday that “as of today the deal still works.”
If Treasuries rise another 100 basis points, then it doesn’t, she said, declining to say at what point interest rate-wise the deal fails to generate sufficient savings. “We could get to a point where it doesn’t work.”
In addition, political considerations also remain in play. “I think it makes financial sense but I’m not a politician” and there are “other factors that influence” how policies are executed, she added.
Emanuel's fiscal legacy would be influenced by the long-term effects of any borrowing.
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.
At that point, Brown said she expected to make a recommendation to the mayor by early September. Some members of the council’s Progressive Caucus and market participants believed the administration’s review was a done deal and would be introduced in late September. The caucus has expressed fears the administration would seek to advance the deal through the council without sufficient scrutiny.
Then Emanuel threw the fast track into a tailspin when he rocked the local political landscape and fueled market worries over the city’s future fiscal direction with his September 4 announcement that he would not seek a third mayoral term in February's election.
Brown said in September that the mayor's announcement pushed back the city’s timeline for a deal because more discussion was needed with aldermen and investors, and she refused to be pinned down on a schedule. Brown said Thursday the potential deal was never tied to the timing of the city budget.
“Things have changed from Aug. 2 and the biggest thing was that the mayor decided to run,” Brown said Thursday.
In the meantime, Treasuries are on the rise. The 10-year Treasury was at 3.22% and the 30-year at 3.39% as of Wednesday compared to 2.98% and 3.12%, respectively, when the idea was pitched in August. The POBs would be sold as taxable paper so they are priced off the Treasury market.
When the city began exploring the idea with bankers early in the year, according to sources, rates were even lower. The year opened with the 10-year at 2.46% and the 30-year at 2.81% and with some fluctuations back and forth have mostly been on the rise.
Brown in previous interviews had said she worried over the expected rise in rates as the policy-making Federal Open Market Committee had signaled at least one to two additional federal fund rate hikes this year and that if the city moved forward she anticipated doing so this year.
Market sources since have said there were had been discussions about breaking the deal into pieces and perhaps waiting on some until early next year. Brown said all options remain on the table.
Critics of the city’s consideration of POBs include civic organizations, public policy and fiscal academics, and some market analysts and investors who question the risks of an arbitrage play that requires investment earnings from the bond proceeds exceed the interest the city pays on the bonds over the long term. The Government Finance Officers Association recommends against the gamble.
Some withheld judgment saying they first wanted to see a plan and some said the idea should be considered as a means to bring up funded ratios.
Brown has also repeatedly warned that the POBs would not eliminate the need for additional revenues to stay on the current statutory schedule that puts all the funds on track to reach a 90% funded ratio by 2058.
The city will contribute $1.18 billion next year, rising to $1.67 billion in 2021 as actuarial funding requirements hit for two funds and then $2.1 billion in 2023 when the two other funds are required to receive actuarially based payments. The city has raised property taxes, enacted a water utility charge, and 9-1-1 fee to fund higher payments, but has not said how it will tackle the upcoming funding spikes.
When an actuarial required contribution hits in 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.
The city pays a current discount rate in the 7% range on its $28 billion of unfunded liabilities and that’s in line with its assumed investment earnings, Brown said. The city had been banking on a rate on the taxable paper in the 5% to 6% range.
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 previously said.
