Chicago Mayor Lori Lightfoot’s reliance on state action to help wipe out an $800 million 2020 budget gap and structurally balance the city’s books by 2022 concerns market participants and city council members alike.
They see uncertain prospects that state lawmakers will allow the city to shift to a graduated tax on property sales — the real estate transfer tax or RRTT — from the current flat rate and whether they will revise the tax structure for a Chicago casino.
Chicago Chief Financial Officer Jennie Huang Bennett, along with budget director Susie Park and comptroller Reshma Soni, fielded questions about these concerns Monday at a daylong budget hearing.
“With these two revenue streams we believe we will be on the path toward structural balance,” Bennett said. “We continue to have productive conversations with our partners in Springfield with various legislative leaders as well as the governor’s office and we feel optimistic about our ability to secure those new revenue sources for our budget and the out years.”
The Lightfoot administration is pursuing both objectives in the General Assembly fall veto session that began Monday and runs through Wednesday. It picks up again November 12 to 14. The 2020 budget relies on $50 million from the transfer tax change with $100 million expected annually in future years.
The budget doesn’t bank on the casino revenue, but the city is counting on licensing and future tax revenue to fund pensions and move toward structural balance by a 2022 target. An independent report warned that without tax changes the city may not find a private operator or financing.
Market participants worry about relying on a third party to balance a budget and topping aldermen's concerns is that the alternative fix in the absence of state support or if other projections fall short will require a property tax hike, as Lightfoot has warned. Local taxpayers are fatigued from a record $544 million 2015 increase to bolster pension contributions and levy hikes in recent years for Chicago Public Schools.
State risks aside, market participants say they view the city as heading in the right direction although they'd prefer it occur at a quicker pace.
MARKET
The proposed $11.65 billion budget plugs an $800 million hole with a mix of 60% permanent and 40% one-time maneuvers that include spending cuts, new tax revenue, a $1.3 billion debt refinancing, and a record tax-increment surplus declaration. The city will pay $1.68 billion into the pension system, up from $1.31 billion this year. The city has $30 billion of net liabilities for a system just 23% funded. The city is leaving reserves alone and won't return to past practices of pushing off debt repayment or borrowing for operations.
“I think it looks like it’s a good blueprint, but they need buy-in from Springfield and there are questions over whether some of the efficiencies” the city is relying on for savings pan out, so the market may take a “wait-and-see” attitude on the budget, said Dennis Derby, senior analyst and portfolio manager at Wells Fargo Asset Management. “The deficit wasn’t created overnight, so it won’t be solved overnight. The city is moving in the right direction.”
The market is biased toward “patience” and the budget may give investors just enough to maintain that patience, said Matt Fabian, partner at Municipal Market Analytics. “They are moving in the right direction” and although it will take several years to achieve structural balance at least “the mayor isn’t thumbing her nose at the market. I think the budget is an authentic attempt to get to structural balance in the coming years.”
Still, MMA views the proposal as a “net negative” for the city and school district’s credit quality, which are viewed as closely linked. “Both the size and persistence of the budget deficit, along with its only partial reliance on recurring solutions, imply that Chicago stakeholders are once again being forced to wait for the city to slowly grow into its liabilities while hoping for no material economic, financial, or political setbacks … her main message is for investors to wait another year before drawing opinions on the city’s long-term sustainability,” MMA said.
“It looks like a politically smart budget because it avoided” a property tax hike, but “the mayor is dependent on a third party for solutions and that makes you vulnerable,” said Richard Ciccarone, president of Merritt Research Services LLC. “Our confidence level has to be notched down because there are third parties involved. I think it buys time, but it’s not going to be perceived as a long-term solution” to the city’s challenges until some targets are achieved.
“The devil in the details” on other assumptions achieved through measures like zero-based budgeting, Ciccarone said. “Basically, those numbers aren’t real until they are proven. The plan is good as an architectural drawing, but it’s a matter of being able to execute it.”
S&P Global Ratings considers the risk of relying on state action manageable. “Given that the city is not relying on casino revenue in the 2020 budget, this provides more time to either consider legislation during a later session or detail a contingency plan for the next two budget years,” said a special report published Friday.
“The assumption that the RETT would get a simple majority approval for a July 1 implementation is more conservative than assuming the two-thirds majority required for the law to take effect earlier, on Jan. 1. In our view, current revenue estimates appear reasonable based on historical performance and implementation time frames,” the report reads.
Although less attractive, the city has the option to enact a graduated RETT for fiscal 2021 through referendum.
COUNCIL
Several council members raised concerns about the risk of relying on the state to balance the books along with the gamble that other revenue projections, including the need for federal approval to secure additional ambulance-related fees, will prove accurate and they pushed the finance team for a backup plan.
“I think we are all concerned about what is going to happen in Springfield,” said Alderman Patrick Thompson.
“We will be working on that to the extent that we don’t see the real estate tax change,” CFO Bennett said. “We are still working through it.” Pressed several times on what options are on the table Bennett would only say “we haven’t taken any options off the table.”
Council members also pushed back on the lack of time between the veto session and approval of the budget to address any shortfall. “We will hopefully know before we pass the budget … whether the real estate transfer tax will move forward” and if it doesn’t “we will bring forth an updated revised budget if that is the case,” Park said. The final package is slated to be introduced Nov. 13 for approval Nov. 26.
Some aldermen used the state uncertainty to press for revenue streams that Lightfoot has resisted, including a reinstatement of the corporate head tax on employees and a financial transaction tax.
Legislative sources warn Lightfoot’s agenda faces a tough road and that was underscored this week by a group of state House members from Chicago telling Lightfoot they wouldn't back the real estate transfer tax change without a bigger funding commitment on homelessness initiatives. Gov. J.B. Pritzker’s administration has said “the governor will encourage the General Assembly to give the mayor's proposals their full consideration during the veto session.”
Several aldermen also questioned the prospects for collecting $160 million through improved emergency transport reimbursements under a deal with the state for Medicaid recipients and by raising fees for insurers. Federal approval is also needed. Some also questioned the city’s confidence in achieving the $200 million savings target on its planned $1.3 billion debt restructuring.
FINANCE TEAM’S CASE
The finance team defended the use of one-shots as balanced by even more permanent structural fixes and pointed to the recent S&P bulletin noting as much.
“Clearly one-time solutions are not ideal, but we also have to consider that this is a very large gap,” Bennett said.
Bennett also defended the restructuring in the face of comparisons to past scoop-and-toss practices and acknowledged that the savings level won’t be set until the bonds are sold.
While the plan books the bulk of savings of $200 million in 2020, Bennett said the refinancing won’t “extend maturities or increase debt service in future years” as past restructurings did and the average life of the refunding bonds will remain at 10 years like the bonds being refunded.
“The way we are able to upfront the savings … is in essence taking the savings that comes from those lower interest rates” so that the city will “keep debt service at or lower than the outstanding debt service we are refunding and in essence have all of those savings restructured up front,” Bennett said.
The bond authorization would be introduced in mid-November and Bennett said in an interview last week the hope is to get into the market late this year or early in 2020.
Based on current rates, the savings exceed $200 million and some savings would be seen in future years, Bennett said. The city would refund existing general obligation and motor fuel tax bonds using both its GO credit and a new Sales Tax Securitization Corp. junior lien.
MMA's Lisa Washburn, a managing director, said a debt service schedule is needed to grasp the details of how the upfront savings are achieved without any type of fiscal maneuvering that may be masked by achieving overall lower interest rates.
Washburn also noted the negative view some market participants have of the city’s use of the Sales Tax Securitization Corp. structure that lockboxes a portion of the sales tax to achieve higher ratings. “The more they do under the structure the more debt they are, in theory, prioritizing STSC creditors over general obligation bond investors and retirees,” Washburn said.
Other budgetary details highlighted during the hearing included the increased authorization to cover judgments of settlements by $80 million to $135 million. The city also clarified that it counted $31 million of the $74 million it will get from its $300 million tax-increment financing surplus toward one-shots being tapped to cut the deficit. That’s because the $31 million represents the amount over what the city booked in 2019.
The city also is seeking reimbursement from CPS for $60 million it has covered in pension contributions for non-teacher CPS employees who participate in the city’s municipal fund.
