CHICAGO - The Chicago City Council votes Wednesday on a $1.1 billion general obligation bond restructuring to help the city resolve a liquidity crisis while also providing a big dose of budget relief.
The deal will lay the groundwork, according to Chief Financial Officer Carole Brown, for Chicago to address the $20 billion pension mess that has dragged its bond ratings as low as junk.
"I think it's a critical step" toward restoring fiscal stability by simplifying Chicago's balance sheet and eliminating bank-related risk on its GO credit profile, Brown said Monday in pitching the deal to the City Council Finance Committee.
The financing, which will include both taxable and tax-exempt bonds, will help shed what the city has sought to portray as mostly "legacy" liabilities inherited from former Mayor Richard Daley and prepare the city and council "for some of the financial choices you are going to be asked to make in the future," Brown said.
"This is not kicking the can, this is not shuffling the deck chairs. This is a real step toward .returning to a state of more fiscal stability," she said.
The restructuring cleared the finance Committee Monday after a two-hour hearing during which Brown fielded many questions about, but little criticism of, the city's plan to roll over short-term operating debt onto the city's long-term, $8.1 billion debt load. Given the tax hikes that likely loom as Chicago ramps up public safety pension payments next year, many council members appeared ready to swallow the bitter pill.
Brown, who left her position as a public finance banker at Barclays last month after Mayor Rahm Emanuel asked her to take the city's financial reins following the departure of Lois Scott, labeled the refinancing debt "clean up" bonds.
The deal allows the city to eliminate the remaining general obligation-related portion of the $2.2 billion liquidity headache created in May when Moody's Investors Service downgraded to speculative-grade Ba1 Chicago's $8.9 billion of GOs, sales tax, and motor fuel bonds and downgraded another $3.8 billion of water and wastewater bonds lower on the investment grade scale.
The downgrades permitted banks to demand repayment of debt tied to floating-rate paper, swaps, and the city's short-term commercial paper and credit lines. The liquidity threat prompted Fitch Ratings and Standard & Poor's to also lower the city's rating within the investment-grade category.
The city in recent weeks shed more than $900 million of the potential problem by converting floating-rate GO and sales tax bonds to fixed rate, shedding the letters of credit and bank facilities that fell into default after the downgrade.
"We must continue to act expeditiously to avoid future capital calls of over $900 million," Brown told the council members during her first appearance before the committee as CFO. "Now it's time to reduce the balance."
The proposed financing, the largest of Emanuel's four-year tenure, also incorporates tactics frowned up on by analysts and investors to provide near-term relief at a greater long-term cost, including pushing off principal payments and borrowing to cover operating costs like judgments. They are strategies Emanuel and his administration inherited but continued, though the mayor has said the city will move away from them in the coming years.
"Recent success by the city to mitigate near-term cash and credit concerns have (mostly) come at the expense of long-term credit quality," Municipal Market Analytics wrote in its Monday outlook. "Holders should assume little upward momentum in ratings and, reasonably, magnified downside potential should headline risks materialize this summer."
UNTENABLE
Brown told the committee the city can't leave the short term paper outstanding with forbearance agreements that expire Sept. 30 hanging over the program.
"I think it's untenable," she said.
The banks that provide the city with credit lines include BMO Harris Bank, Bank of America, Morgan Stanley, Barclays, and JPMorgan.
The city intends to move about $800 million of debt in its short-term borrowing program into a long term, fixed-rate structure, piling it on to a more than $8 billion debt load over a 30-year term.
Morgan Stanley is senior manager with William Blair & Co. and Siebert Brandford Shank & Co. as co-seniors. Another eight firms round out the syndicate. Acacia Financial Group is advising the city. Chapman and Cutler LLP and Hardwick Law Firm are bond counsel and Duane Morris and Shanahan & Shanahan are disclosure counsel. The city expects to enter the market over the next month.
Debt currently outstanding in the short-term program includes $192 million to cover interest-rate swap termination fees attached to the recent conversion of its floating rate GOs, and another $151 million that went to help complete the conversion.
The deal gives the city short-term budget relief by funding $62 million to cover a legal judgment tied to the prior administration's violation of the city's parking garage lease. It also covers $35 million for loans tied to land purchases made as part of the city's failed bid for the 2016 Olympic Games, other judgments, and $170 million for a "scoop-and toss" refinancing for 2014 budgetary savings by moving principal payments into the future. The city also will cover over a two-year timeframe a $75 million retroactive pay raise.
The city also gets budget relief by building $170 million of capitalized interest into the deal for the first two years.
The city will use $180 million to cancel a 2005 leveraged lease transaction involving the Orange Line rapid rail transit line to Midway Airport. The Moody's default triggered a default on city's letter of credit reimbursement contract with PNC Bank.
Brown told committee members that rating agencies and the investor community view the city's plan favorably, citing a commentary released by Moody's late last week calling the recent conversion of floating-rate paper to a fixed rate a credit positive. Moody's has not commented on the proposed restructuring.
Some council members questioned the selection of Morgan Stanley to lead the transaction given the city's much-maligned lease of its parking meter system to a fund managed by Morgan Stanley. Brown was also questioned over her past role as a public finance banker who worked on bond deals for Chicago and other area issuers that included floating-rate deals with swaps.
"We recommended financial structures to meet the needs of those municipalities and issuers at the time," she said. "We communicated and tried to explain the risks associated with those transactions" and she said they helped municipalities achieve "their short term goals for savings."
Brown noted the city seeks in its underwriting picks to meet minority and women-owned participation levels while recognizing local firms and those banks that provide support. Morgan Stanley gave the city a boost when needed by agreeing last month to increase an existing credit line by $200 million. The former mayor's nephew, William Daley, is a public finance banker in the Chicago office working on transaction.
Once the sale is completed, the city's remaining liquidity issues stemming from the Moody's downgrade involve principal repayment on $332 million of wastewater debt and $25 million of swap termination cost in addition to $110 million of potential swap terminations on water debt.
A document provided to council members reports that the city "may need to convert variable-rate bonds and terminate swaps. The city continues to monitor the situation."
The city has not said how large a short-term borrowing program it will maintain. "We will keep the line of credit for liquidity purposes," Brown said.
Chicago will return later this year with a new money and refunding issue that will include more scoop-and-toss refinancing. Emanuel recently announced he would phase out the practice by 2019 and would reduce the level of operating expenses like legal judgments pushed on to the city's long term debt load.
The city plans to push off another $550 million in the coming years, including $250 million in principal repayment this year, $150 million in 2016, $100 million in 2017, and $50 million in 2018.
When asked by one council member why the city isn't eliminating scoop-and-toss now, Brown said the city's decision to instead phase it out was designed to "mitigate the impact on taxpayers."
Brown said the restructuring will help the city tackle tough decisions ahead that stem from a $550 million spike in public safety pension contributions due next year to put the systems on an actuarial funding basis.
State lawmakers passed a bill that would reduce next year's increase by more than $200 million, but its fate is uncertain at the hands of Gov. Bruce Rauner given a state budget impasse.
Most market participants believe a property tax hike is inevitable but Emanuel has not laid out a revenue plan and is seeking state approval for a Chicago-based casino.
Alderman John Arena voiced frustration over the continuing absence of a revenue plan. Without a revenue plan Arena called the restructuring plan "irresponsible."
"It makes it very hard for me to support this strategy because I don't know the strategy," he said. "You've got to start showing us the plan If we had had these conversations about revenue years ago maybe we wouldn't be paying these extra two and three quarter's percent."
Brown countered that it "would be irresponsible not to proceed."
OPPORTUNITIES SEEN
The removal of rating triggers from the city's financial profile reduces the risk of liquidity concerns should other rating agencies chose to downgrade now or in the distant future, MMA said.
"Exchanging long term costs for near-term savings is (or should be) a crisis management technique that only raises total expense of funding the city's obligations," MMA wrote. "For a city still unwilling to tap its revenue base to bring budget balance, this implies a long term struggle for budget balance and only thin cushioning against headline developments."
Like MMA, Barclays municipal credit research team sees opportunities for the right buyers.
"In our view, at current levels, both taxable and tax-exempt Chicago GOs present attractive strategic opportunities for investors who can stomach volatility," Barclays wrote Friday. "Despite our bullish strategic view on the credit, tactically we recommend adding exposure on dips, rather than chasing rallies. We envision volatility as the city deals with its pension issues."
The city has paid steep yields to borrow with spreads on its GO remarketing last month ranging from 264 basis points to 293 to Municipal Market Data's top-rated benchmark.
The city's GOs carry an A-minus rating on CreditWatch with negative implications from Standard & Poor's; a BBB-plus on negative watch from Fitch Ratings; and Kroll Bond Rating Agency affirmed Chicago at A-minus with a stable outlook. The negative watches are due to the liquidity pressures.
