Chicago city council may scrutinize securitization structure
CHICAGO — Chicago’s $1.3 billion pending sales tax securitization needs a public vetting to gauge the long term fiscal impact of its 35-year structure that goes out a decade past the debt it would refund, a civic research organization told the City Council.
“The federation has serious concerns about the possible use of the STSC structure for the refunding of $1.3 billion of existing debt,” Chicago Civic Federation president Laurence Msall told council members at a public hearing on Mayor Rahm Emanuel’s proposed 2019 budget, which the federation supports.
The Wednesday hearing coincided with the anticipated pricing of the Sales Tax Securitization Corp. deal, which the city delayed citing choppy market conditions. City officials had left open in recent weeks the possibility of moving the sale as it watched the market but was ready to move forward earlier this week as initial pricing whispers circulated.
Further council scrutiny may be ahead.
The Progressive Caucus planned to draft a resolution to call for a hearing on the deal, said its chair, Alderman Scott Waguespack. Finance Committee Chairman Edward Burke left open the door for a review, saying it was not too late although it’s unclear what a review would entail.
A Burke representative could not immediately be reached. The city’s finance department has not been contacted by the Finance Committee to further discuss the previously authorized deal, said department spokeswoman Kristen Cabanban.
The borrowing program securitizes Chicago's state-collected sales tax through a “true sale” of the pledged taxes to a bankruptcy-remote, special-entity corporation, landing much higher ratings than the city's general obligation credit.
The Civic Federation has generally been supportive of the securitization program, created in 2017 state legislation, as a “creative way to manage its high debt burden,” but the long-dated structure on the final tranche prompted concerns.
The federation pointed to the 2053 maturity on more than $900 million in the final tranche of bonds the Sales Tax Securitization Corp. had planned to issue this week to close out an up to $3 billion authorization to refund sales tax and GOs at lower interest rates. The savings are accomplished because of the securitization’s high-grade ratings.
The deal goes out 13 years past the final maturity on bonds the city intends to refund and 10 years past the final maturity on any city GOs.
“While city officials have explicitly said this will not be scoop-and-toss — because of the reduced borrowing costs and the net present savings — we are concerned that the city might consider transactions that extend the maturity of debt in order to achieve short-term budgetary relief,” Msall said.
“This would significantly reduce savings for city taxpayers,” he said. “The federation urges city finance officials to provide this council and the public with more information about how this and any future refinancing could impact future budgets, future generations of taxpayers and the city’s future capacity to borrow for important capital and other expenses going forward.”
The administration has said it does not plan any transactions after the pending STSC deal.
Msall’s testimony prompted questions from aldermen asking how the pending transaction differed from the previous two and whether the federation believed the structure resembled the scoop-and-toss debt restructurings of the past, in which the city effectively borrowed new money to pay off maturing debt. In his second term, the Emanuel administration has made a loud point of discontinuing the practice.
It’s the long-dated maturities past the refunded debt that triggered the federation's worries, Msall said. “We just have not seen why that’s necessary” and whether it’s “not just to provide budgetary relief,” he told aldermen.
“I appreciate you bringing up the sales tax” deal, Progressive Caucus member John Arena told Msall. He said the caucus had concerns during the council’s initial review last year that the city was “repeating the same practice under a different cover.” He asked whether Msall considered the structure a version of scoop-and-toss.
Msall stopped short of labeling the structure as such because of the interest rate savings achieved and said the city has used the securitization “effectively” to reduce borrowing costs.
Former mayor, Richard M. Daley, began the practice of pushing off some near-term principal payments annually to hold the levy for debt service level. That added to the city’s overall interest costs. Emanuel began phasing out the practice a few years ago and it ended last year.
The securitizations are providing $700 million in budget relief over five years. That eased the impact of the elimination of scoop-and-toss. The deals are also smoothing out the city’s long-term debt service and reducing interest cost through net present value savings.
Chicago finance chief Carole Brown in an interview Friday rejected the comparison, arguing that the securitization bonds put the city’s debt service on a level and manageable path with reduced interest costs. Brown also faced a balancing act between leveling out debt service repayments with how much the budget could spare in sales taxes for the securitization.
“The goal was to refund high-cost GO debt with lower-cost debt, to remove from the city corporate fund the need to scoop-and-toss and to finally get to a place where we had a rational borrowing policy and strategy and to lower the overall cost of debt,” Brown said. “I think this is a responsible way to do it.”
Municipal Market Analytics said Chicago's plans point to a flaw in industry practices.
“MMA recommends new primary market disclosure best practice recommendations (or, if not widely implemented, regulatory requirements) that any prospectus for a public or private refunding transaction always include a comparison of the actual transaction to a hypothetical principal-matched version, wherein the refunding bonds’ principal schedule proportionately matches the schedule of principal being refunded,” MMA said in its weekly outlook.
“This report would flatly illustrate the choices debt managers are making between aggressive and conservative financing alternatives,” MMA said.
After meetings with investors during which the city saw strong interest it decided last Thursday to double the size of the securitization deal to $1.3 billion so it could wrap all borrowing under the $3 billion authorization, beat the possibility of rising rates, and complete the program before Mayor Rahm Emanuel leaves in May. Emanuel is not seeking re-election.
The city faced headwinds from some uptick in yields and it was hurt by S&P’s revised criteria for priority-lien tax revenue credits, all of which gave the buyside a stronger hand in pricing. The revised criteria drove a one-notch cut in the bonds’ rating last week and a five notch hit to the state’s more traditional sales tax bonds Tuesday.
While the city’s structure is a “true sale” of pledged receipts to a bankruptcy-remote entity and the state’s is a traditional revenue credit, the state downgrade was especially damaging because the market had only begun to digest the negative headline since it came late Tuesday, multiple market participants said.
The bonds carry AAA marks from Fitch Ratings and Kroll Bond Rating Agency and AA-minus from S&P Global Ratings. Under the revised criteria, S&P concluded the securitization is capped at four notches above the obligor’s rating and it rates the city GOs BBB-plus. The city’s GOs are rated Ba1 by Moody's Investors Service, BBB-minus by Fitch Ratings and A by Kroll Bond Rating Agency.
Spreads on the city’s previous STSC deals — a $744 million transaction in December and a $680 million sale early this year — ranged from 26 bp to 61 bp on the tax-exempts with the December sale faring better than the January issue. The long taxable bonds in each sale landed at 87 to 88 bp to Treasuries.
MMD in its “municipally speaking” column this week said it’s received continuous inquiries over city GO spreads since Emanuel announced in early September he would not seek a third term.
“Since that date spreads on Chicago GO bonds have improbably seen spreads” decline relative to the AAA GO benchmark, the piece said. That was viewed as a surprise because the municipal market generally views Emanuel in a favorable fiscal light for raising taxes to improve pension funding and trimming the city's structural deficit.
MMD observed a trade on a 2035 bond Tuesday at a 133 bp spread. That compared to 143 bp and 146 bp in August trades before Emanuel’s announcement. Some have speculated it’s due to market perception that the $10 billion pension obligation bond issue being explored by the administration is now less likely.
Chicago GOs are not frequently traded and the secondary has been especially quiet ahead of the sales tax securitization deal, MMD senior strategist Daniel Berger said in October. Traders said the market may be waiting for the securitization bonds to sell to better value Chicago’s GOs. Others have said some may have been leaving open positions should the city proceed with the POBs.
"The municipal bond market should see increased traffic in this debt as the sales tax securitization comes to fruition,” MMD said in its column.