CHICAGO – Chicago will soon move to take advantage of a new local government borrowing vehicle established in the state budget package with an eye to refunding up to $2.5 billion in multiple transactions for interest savings.
Mayor Rahm Emanuel announced the city's plan to proceed at the city’s annual investors’ conference Wednesday. Chicago's chief financial officer Carole Brown enlisted several local law firms to craft the legislation, but city officials kept their plans quiet until Wednesday.
Administration officials said Wednesday the plan is to tap into the program by siphoning off and leveraging a portion of its share of state sales tax revenues. The city is looking at refunding its $515 million of outstanding sales tax revenue bonds and up to $2 billion of general obligation bonds that are callable over the next three years. The city has about $10 billion of GOs.
“Initially the recommendation will be to use the mechanism to refund callable general obligation debt,” said a city official. “We are also evaluating the existing sales tax bonds.”
Emanuel will introduce to the city council as soon as next month an ordinance laying the groundwork for the creation of a special purpose entity. The city would assign a portion of sales taxes collected by the state to the special entity to leverage in a borrowing.
Emanuel said the program provides the city with a new tool that allows it to issue debt “in a way that is much more financially viable to the city.”
The program is designed to bypass the city’s weak bond ratings, which include a junk rating from Moody's Investors Service, by insulating the bonds and assigned revenues from the risk of being dragged into bankruptcy.
Fitch Ratings has said similar structures in other states such as New York have garnered AAA ratings.
The city is not currently considering a new money deal under the program. "We are currently evaluating" refunding candidates, said a city official. "We would do it for present value savings.”
Multiple transactions are planned with the city aiming to complete the first one by the end of the year. The administration has not selected financial advisors or underwriters. The city also has “to complete the ratings process” and then reach out to investors, the administration official said.
"There's no reason to do a mega deal," based on feedback from market participants, said the city official. The first transaction will introduce the credit to the market so it will set a pricing floor. The city expects that subsequent transactions would price at tighter spreads based on market feedback.
Chicago officials expect substantial savings. Bankers have told the city if it can garner high-grade ratings that spreads should fall short of 100 basis points while the refunding candidates carry yields that represent at least a 160bp spread.
While the program is not yet being tapped for new money it could eventually replace some GO borrowing. The city last sold GOs earlier this year in a $1.2 billion deal but does not plan to return until 2019. The city saw its spreads hit a new high of 339 bp to 347 on the sale.
Spreads has since narrowed by about 50 basis points following passage of a state budget last month that included the local borrowing program and the final piece needed to implement the city’s pension funding overhaul.
The new program allows the state’s 200 home rule municipalities to dedicate or assign tax revenues they receive from the state to a special limited use entity. The structure, and features such as a statutory lien, was designed to win higher ratings and in turn lower borrowing costs.
“If properly applied by a home rule entity, the structure could result in ratings higher than and without regard to the issuer default rating,” Fitch wrote in a recently published report.
Fitch was the first rating agency to weigh in with an assessment of the “assignment of receipts” program created in the state budget package that became law last month after lawmakers overrode Gov. Bruce Rauner’s veto.
Revenue streams that municipalities could tap include their share of personal property replacement taxes, gambling, sales tax, local government distributive fund revenue, and motor fuel tax revenues.
The new borrowing structure raises concerns for some market participants.
Such structures are typically created in an environment where stressed credits are looking to lower borrowing cost, but those efforts are undertaken without regard for the value of existing bonds that could be harmed by the diversion.
“You are carving out a piece of the pie. The pie isn’t getting any bigger,” Joseph Rosenblum, director of municipal credit research at AllianceBernstein, said in a recent interview. For existing holders the revenue stream is being diluted, he said, so right away the older debt is weaker credit-wise.
If a government’s credit grows more stressed, existing holders could see further loss of liquidity and value as the alternative structure may be viewed as more sound.
Municipal Market Analytics said lowering borrowing costs is a positive for Chicago, but the city must show discipline. “If borrowing costs are reduced as the state and city likely expect, there could be an incentive for the city to increase its debt load,” MMA wrote.
“Investors holding callable, high coupon Chicago bonds should anticipate the heightened risk of seeing their bonds redeemed,” MMA added. Even with the addition of the statutory lien, MMA said the soundness of the structure could be tested as some have been in other bankruptcies.
Some rating agencies directly link the city’s GOs and sales tax ratings while others don’t.
Moody’s has both in junk territory. Fitch Ratings assigns a BBB-minus and stable outlook to both. Kroll Bond Rating Agency rates the city’s GOs BBB-plus and its sales tax bonds AA-plus. Both are stable. S&P rates the city’s GOs BBB-plus and stable while the sales bonds are at AA and stable.
The city would free itself of bond covenants if it refunds the sales tax bonds. It put on hold a new money issue earlier this year with the legislation pending.
The sales tax bonds enjoy a first lien on the city's 1.25% home rule sales and use tax and the city's local share of state-distributed 6.25% sales and use tax. Sales and use taxes this year are budgeted at about $700 million. Home rules sales taxes totaled $352 million last year and local share sales taxes totaled $363 million, Kroll said in a recent report.
Collections are sensitive to economic times with declines of 9% to $13% seen during the last recession. They have in recent years grown at about a 3% clip.