CHICAGO — Chicago's general obligation bond ratings will remain pressured until the city fully fixes its pension mess, top city finance officials told aldermen this week.
They also warned the City Council not to expect to use reserves to ease the pain of a $550 million pension spike scheduled in 2016.
The comments came from Chief Financial Officer Lois Scott and Budget Director Alexandra Holt on Monday's opening day of hearings on Mayor Rahm Emanuel's proposed $7.3 billion 2015 budget.
In their budget overview, Holt and Scott highlighted what they described as fiscal accomplishments that range from chipping away at the city's structural budget imbalance to reducing the threats posed to the city's swaps and bank credit portfolio from its credit rating deterioration.
While the two acknowledged the daunting pension challenges that remain, those woes largely took a backseat during the daylong hearing in which council members grilled Holt and Scott on police overtime, tree trimming, pothole filling, and neighborhood capital spending.
The pension subject did arise in some of the questioning and both threw cold water on the idea of tapping the city's $620 million of reserves, funded primarily with proceeds of its 2005 Skyway toll bridge lease, to deal with the payment spike due in 2016 under a state mandate.
The city's bond ratings have taken a pounding over the last year, with its reserves providing a bright spot. Rating agencies and investors look favorably on the reserves, Holt said when asked by council member Pat Dowell if the city would consider tapping the account.
Scott called the rising pension payments "an ongoing challenge" in need of a "longer term solution."
Former Mayor Richard Daley dipped deeply into reserves set up with proceeds of the city's parking meter lease to close gaps in his last few budgets. He did not seek re-election in 2011 after more than two decades in office.
Council members challenged little in Emanuel's spending plan that forgoes a property, sales, or gas tax hike to close a nearly $300 million gap in favor of more politically palatable methods including spending cuts, management efficiencies, and more minor tax and fee increases.
In response to a question on the city's ratings from council member Joe Moore, Scott addressed the city's credit deterioration driven primarily by its $19 billion in unfunded pension obligations.
It was hit last year with three-notch downgrades from Fitch Ratings and Moody's Investors Service. Moody's struck again with a single notch downgrade this year while Standard & Poor's has revised the city's outlook to negative.
Chicago "is an outlier relative" to other cities' pension obligations and the rating agencies have "focused heavily on what we are doing to address our pensions," Scott told council members and until the city fully solves its pension mess the rating will continue to feel "pressure."
The city won state approval to overhaul benefits and contribution levels for its municipal and laborers' funds earlier this year although it will take years to see significant improvement in the unfunded levels.
The city's police and firefighters' funds pose a daunting challenge due not just to the size of their liabilities but a statewide requirement that requires local governments in 2016 to shift to an actuarially required contribution.
The city's 2015 scheduled $557 million payment to its four funds will rise to more than $1.1 billion due to the change. Emanuel is banking on state action to overhaul the two funds and delay the spike, possibly as part of a statewide package that includes other local governments, but he has offered up no alterative solution to the frustration of investors and analysts.
"Further downgrades will make it increasingly difficult to efficiently finance the city as well as deal effectively with the legacy credit portfolio," Scott warned in her presentation.
In addition to the partial pension overhaul, Scott outlined other strides aimed at stabilizing city finances including the continued phasing out of retiree healthcare subsidies, although that effort faces a legal challenge, and $45 million in deposits to reserves including $5 million in next year's proposed budget. The city has altered some of its debt management practices, held its fourth annual investor conference this summer, and hosted its first annual credit support provider conference.
The city is "working to reduce our long-term debt burden by paying for more costs out of the city operating budget or through short-term debt instead of using 30-year debt obligations," Scott said.
Chicago has come under fire for issuing debt to cover judgments and settlements and retroactive salary increases. In response, it's raised budgeted levels to cover settlements and increased the use of cash or short-term borrowing to help cover retroactive pay hikes.
The city has discontinued the use of variable-rate debt and swaps and sought over the last year or so to reduce the risks attached to its $6 billion portfolio of bank credit and swaps.
"Including the amendments in process, we have reduced the risk of termination of over $300 million of letters of credit on general obligation variable rate bonds, $600 million of letter of credit and lines of credit on the city's commercial paper program and approximately three-quarters of the GO swap portfolio mark to market," Scott said in her statement.
In its most recent offering statement, Chicago laid out its swap and liquidity termination or acceleration risks in new, more prominently displayed disclosure that made clear it is as little as one downgrade away from potential swap termination events.
The city - which pays steep interest rate penalties on even its stronger rated credits due to its fiscal woes -- sold five deals this year including GOs, water and sewer debt, Midway Airport bonds, and a motor fuel tax issue.
The city's capital improvement program for 2015 totals $2.19 billion, including $972 million for aviation projects. About 12% of the non-aviation capital spending would be funded with GO borrowing although the city has not offered a size on any long-term borrowing planned borrowing next year.
The proposed $7.34 billion budget includes a corporate fund that will rise to $3.5 billion from $3.3 billion. When grant funds are added the budget rises to $8.9 billion. The city faced $300 million of red ink headed into budget season. It was erased with $50 million in non-personnel savings and spending reforms, raising $26 million from improved debt collections, $31 million from eliminating vacancies, and healthcare savings by continuing with plans to phase out most retiree healthcare.
The city would trim another $60 million by capturing some surplus tax-increment financing revenues. An additional $75 million is expected in higher-than-anticipated tax revenue growth. Revenues from hotel taxes are expected to grow by 3%, property tax transfer taxes by 5%, and building permits by 7%. The city would raise $54.4 million from various tax increases and by closing tax loopholes.
The city would raise its parking tax for the third year in a row, and raise vehicle, software and other leasing fees. Emanuel would extend an amusement tax on stadium skyboxes and cable television, and the city would crack down on what it calls sales tax collection loopholes that companies capitalize on by receiving products in the suburbs.
The city initially planned to raise the property levy by $50 million in 2015 to fund increases to its laborers and municipal employees' pension funds, but state lawmakers gave Chicago the go-ahead to raise its emergency services surcharge on phone bills to offset the need to rely on property taxes.
The city's GOs are rated A-minus by Fitch Ratings, Baa1 by Moody's Investors Service, and A-plus by Standard & Poor's. All assign a negative outlook.
Hearings on the budget will continue over the next month with the council expected to vote on the plan Nov. 19.
Market participants agreed with the city finance team's comments on reserves and credit pressures.
Fitch Ratings analyst Arlene Bohner called the city's reserves "an important element" of the city's fiscal flexibility in its credit profile.
The city's ratings are "sensitive to the city's ability to implement a realistic plan that puts all of the city's pension plans on a path toward improved funding that allows for the continuation of the city's progress toward structural balance," she said.
"We agree with Mayor Emanuel's strong stand on maintaining the city's reserve funds and keeping the pressure on Springfield to resolve the pension situation," said Triet Nguyen, a managing director at the independent advisory firm New Oak. "When it comes to pension funding, Chicago is really being held hostage by the state, which is trying to clean up its own pension act. Unfortunately, in this election cycle, all the politicians have already tied their own hands by taking property tax increases off the table. This leaves precious few options available to local governments to address their current budget issues."
