Chicago investors fret after city showcases progress

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CHICAGO – Big projects like the overhaul of O’Hare International Airport and cranes dotting the downtown landscape left a positive impression on market participants at Chicago’s annual investors’ conference.

But the signs of growth and other fiscal accomplishments fell far short of calming their worries over longer term pension ills, the school district’s precarious finances, state political dysfunction, and plans to establish a new borrowing tool.

"The investor conference was a success in as much as the trajectory of the economic condition of the city is better than when mayor took over” in 2011, said Brian Battle, director of trading at Chicago-based Performance Trust Capital Partners.

“The cloud that’s hanging over the city is what’s going on in Springfield at the state capital,” Battle said, referring to the current logjam on an overhaul of funding formula that is holding up distribution of general state aid to CPS and more than 850 other districts. It’s the latest battle front between Gov. Bruce Rauner and the General Assembly’s Democratic majority.

Two days after the conference, CPS announced its $5.75 billion fiscal 2018 budget relies on $300 million more of hoped-for state aid and $269 million of unidentified city help. Though there’s been speculation of taxing downtown businesses or freeing up more tax increment financing dollars, Emanuel has remained silent on the form such aid will take.

Details on how the city will meet a big jump in pension payments in the coming years, when actuarially based contributions kick in, remained elusive, and Emanuel’s launch of a new securitzation-like borrowing program has some concerned over the impact on the value of existing debt.

“There’s no question they’ve made progress and economic tours gave you a visible look at the bricks and mortar of economic activity going on,” said Richard Ciccarone, president at Merritt Research Services LLC. “But there’s a long way to go.”


Emanuel announced at the Aug. 9 conference the city's plan to soon take advantage of a new local government borrowing vehicle established in the state budget package.

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. The city initially is eyeing the refunding of up to $2 billion of general obligation bonds and $500 million of sales tax bonds in multiple transactions for interest savings.

There was “definitely a lot of discussion and concern” about the program which is its infancy in Chicago, but is familiar to the market from structures used in New York, Washington, D.C., and other cities, said Howard Cure, director of municipal bond research at Evercore Wealth Management, LLC.

Use of such a program illustrates a borrower’s distress, he said. New York City tapped the structure as it hit borrowing caps, Cure said, and other cities did so because they were locked out of the market.

On the plus side, the program is likely to lower city borrowing costs due to the expected higher-grade ratings. It could lure back buyers that have shunned city bonds since Moody’s dropped it to junk in 2015. The market reacted favorably to the announcement by trimming 40 to 45 basis points off GO spreads in trading the following day.

But Cure said the ultimate level of interest savings remains to be seen. Buyers might be skeptical given the blows they’ve taken in bankruptcy cases on some credits they thought air tight such as Puerto Rico’s sales tax bonds.

Several others offered a similar assessment saying an investor can’t be confident in a structure until it’s truly tested by the courts. Investors might want additional assurances that the structure is bankruptcy remote, beyond a simple bond counsel opinion, Cure said.

The implications for current GO bondholders also remains clouded, despite the improved spreads seen last week. “You are not increasing the pie, you are just whittling away potentially at the pledge for basic GO bondholders” and that could eventually cause spreads to widen, Cure said.

Another buyside analyst added that the city will need to show restraint in adding new debt to the city’s balance sheet or it risks canceling out the fiscal benefits of lowering existing interest costs.

Chief financial officer Carole Brown plans to tap into the program by siphoning off and leveraging a portion of its share of state sales tax revenues.


New and higher taxes are funding a steady rise in payments to the city’s four pension fund until funding hits the actuarily required contribution level in 2019 on public safety funds and in 2022 on the city’s two other funds. The city has $35.7 billion of net pension liabilities.

When asked after his address on future funding sources for pensions, Emanuel didn’t offer details, simply saying the city would adhere to the “more balanced” approach that he’s favored since taking office.

The hope is that efforts to promote natural tax growth through an improved economy and whittling away the structural deficit – which is down from more than $600 million in 2011 to $114 million this year -- will better position the city to meet the future increases. The improvement has come as the city also is weaning itself off of scoop-and-toss debt restructuring and using debt to cover judgments and settlements.

“I am not going to make up in two or three years what took 30 years to create,” the mayor told the attendees.

“They are very dependent on economic growth and controlling growing expenses to mitigate that burden,” Ciccarone said.

Market participants said they’d like more detail on potential revenues and it's risky relying on economic growth, which is cyclical. Emanuel did score some points for raising taxes to address the pension mess, even if some believe the increases fall short of what’s needed now.

In dealing with the pension issue, the city faces the added burden of so-called “cluster risk” as its sister agencies, Cook County, and the state all are grappling with pension underfunding and the need for more revenue.

“You wonder how much the economy can withstand,” Cure said. “Illinois still has pretty low taxes overall so there’s room to grow” but the concern is tax fatigue. The county has turned to higher sales taxes to deal with pensions and a new, unpopular sweetened beverage tax to deal with its deficit. The state just lifted income tax rates.

“The message I got is that the mayor wants to be careful about raising taxes because it impairs economic activity,” Battle said. “But they have raised taxes and so I think you have to give him some latitude because the city has made some tough choices.”

CPS’ rocky finances and the looming cost of city help also weighed heavily on investors’ minds, with a handful saying in interviews that the city must act. CPS and the city may be two separate governmental entities, but the link runs deep. Emanuel appoints the school board and major decisions are run through city hall.

“The city doesn’t have a choice,” Battle said. “They have to keep the third largest school system in the country open and the city has the wherewithal” to help.

“It’s a costly proposition…..but you can't separate the city's future and from the school district,” Cure said.

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