Chicago mayor sends signals to the muni market, without details
The municipal bond market has a message for first-year Chicago Mayor Lori Lightfoot: go light on one-time maneuvers, avoid fiscal gimmicks, and move the city toward structural balance.
Lightfoot must solve an $838 million budget gap next year and potential billion-dollar deficits in the following two years.
“We are looking for a reliance on structurally balanced measures to close the gap," said Carol Spain, lead analyst for Chicago at S&P Global Ratings, which rates the city's general obligation debt BBB-plus.
If the city is using one time sources, S&P would look for “the structural gap to be closed within the near term in the next couple years,” she said. “What we are looking for is a credible plan” that doesn’t solely rely on measures requiring state approval that might not come to pass or that are cyclical or volatile in nature.
Lightfoot laid out the numbers in a state of the city address last Thursday and in a budget forecast. She also offered some ideas that will likely wind up part of a plan when her 2020 budget is unveiled in mid-October. The city is currently operating on a $10.67 billion budget.
Corporate fund revenues of $3.83 billion will fall about $838 million short of $4.67 billion in expected expenses primarily due to rising personnel, debt, and pension costs. The number doesn’t anticipate any natural revenue growth and the overall numbers count both annually recurring costs and one-time expenses like retroactive pay raises.
Lightfoot won praise for laying out the city’s strains and some potential options in a speech broadcast on local television stations Thursday.
But many market participants had anticipated a more detailed road map, earlier in the summer, to stabilize the city’s fiscal health. In the week before the speech, Lightfoot portrayed it as laying the foundation for a budget plan and longer-term solutions.
“I was impressed with her goal of transparency and her statement about being willing to do the right things” at the risk of her political career, Spain said. “But I also think what we were looking for … was to get more transparency as to what her plan really is … the market is looking for more certainty.”
S&P published a report Monday authored by Spain titled "How Chicago Closes Its Fiscal 2020 Budget Gap Will Be Pivotal To The Rating ."
Focusing on just the numbers for now, however, may lay the groundwork for building not just state but also city council support.
Deficits of $1.19 billion and $1.16 billion are projected in 2021 and 2022, respectively, on a baseline forecast that doesn’t account for revenue or expense changes in 2020.
Chicago has a $30 billion net pension liability, and pension contributions rise to $1.68 billion next year, when an actuarial contribution requirement hits for the police and fire funds, from $1.3 billion this year, rising to $1.8 billion in 2021 and $2.25 billion in 2022 when the municipal and laborers’ contribution is required to hit actuarial requirements.
“If $838 million sounds big, it’s because it is. It’s the largest in our recent history,” Lightfoot said.
Early indications in her speech and subsequent interviews suggest Lightfoot is well aware of what the municipal market is watching for.
Sticking with the pension funding ramp is a priority because the plans put in place by predecessor Rahm Emanuel with legislative approval saved two of the four funds from insolvency, but they will remain in negative cash flow for years with improvements in funded ratios below 30% taking years to achieve.
“The budget gap is a really big number considering we have a $10 billion all funds budget,” but when you are coming into office it’s expected that “you kitchen sink it so you can blame the last person,” said Brian Battle, director of trading at Chicago-based Performance Trust Capital Partners.
The number will require “new revenue and there’s only a couple places” you can go, Battle said. He expects that a property tax hike is on the horizon. Lightfoot repeatedly puts one down as a last resort.
Battle said the market would frown on any backpedaling toward the gimmicks Emanuel eventually wound down, such as borrowing for settlements and scoop-and-toss debt restructuring, but Lightfoot could “get some latitude to do those things, but only if part of a comprehensive five-year plan” to achieve structural balance.
Battle said he was encouraged that the mayor understands the careful balance she must strike to avoid driving homeowners and businesses. “She does seem to have a longer-term time horizon and understands this is structural thing that has a lot of moving parts,” Battle said.
“I think what she’s done is put together a comprehensive assessment of the financial condition of the city of Chicago,” said Laurence Msall, president of the Chicago Civic Federation, which tracks the city and state’s finances.
Lightfoot has now begun the conversation and outlined the crisis and urgency needed to deal with it, Msall added. He too said the city “can’t afford to back track” and turn again to “fiscally reckless” practices like scoop-and-toss.
Kroll Bond Rating Agency’s lead Chicago analysts, Karen Daly and Harvey Zachem, said the rating agency did not expect more than Lightfoot offered at this point. “We are going to want to know which specific revenue streams will close the gap, what the city has planned with respect to that and over what time period,” Daly said. Kroll rates Chicago GOs A.
Kroll said it had “informally” met with Lightfoot and Kroll and S&P both say chief financial officer Jennie Huang Bennett is in frequent contact.
“It will be interesting to see what she is going to do on taxes," said Howard Cure, director of municipal bond credit research for Evercore Wealth Management. "I’m not sure on what approach she will take, so that’s a concern.”
Depending on state help is worrisome, especially as Gov. J.B. Pritzker wants to focus on voter passage of a constitutional amendment to move to a progressive income tax system from the current flat tax mandate, and city’s requests could also be complicated if the economy softens.
Richard Ciccarone, president and CEO of Merritt Research Services, called the deficit a “herculean” number given the new revenues that may be needed. The city’s revenue hikes in a single year hit a high of $562 million in 2014. “She's now drawn the line and the market will expect to see concrete progress,” but the market also likely will give her the “benefit of doubt” in granting more time, Ciccarone said.
Setting the table
“I cannot in good faith promise you that I will take any option off the table to tackle this crisis, whether it's through budget reductions or by raising revenue,” Lightfoot said Thursday.
During editorial board meetings, Lightfoot and her finance team provided some more specifics on what is on and off the table. The city is not eyeing mass layoffs, Lightfoot said during a meeting with Crain’s Chicago Business.
Lightfoot said any discussion of consolidating downstate public safety pension funds should include the city and called the 3% cost-of-living adjustment that retirees hired after 2011 in two Chicago funds enjoy “unsustainable,” but she stopped short of saying she would lead any effort to alter the formula, which would require a constitutional amendment. Pritzker has thrown cold water on the idea. Lightfoot also then went on to speak of honoring pension commitments.
Lightfoot appeared to take a re-amortization off the table during the Crain’s meeting. “That is something that we talked about early on, but the response from the rating agencies was decidedly negative” and going down that path the city was “looking at a pretty substantial downgrade,” Lightfoot said. “I just don’t see how we could do that.”
She threw cold water on a longstanding push by the teachers’ union to adopt a tax on financial transactions at Chicago-based exchanges. She also is against reinstating a head tax on businesses, fearful that businesses would flee the city.
Lightfoot agreed with an assessment offered during the Chicago Tribune meeting that she would like to see a “revenue source” to deal with local and state government pension woes.
Lightfoot left some form of a pension obligation bond issue on the table, saying it was Emanuel’s $10 billion proposal pitched last year that she opposed.
“I remain opposed to a $10 billion pension obligation bond because of the size” and “because the details of how that bond would be serviced were never fully flushed out,” which led to concerns over how POBs used elsewhere, like in Detroit, backfired, Lightfoot told the Tribune board. On the chances for a smaller issue, Lightfoot said she was “not going to get ahead” of herself.
Chicago’s ratings and spreads remain in the cross-hairs. Lightfoot inherited one junk-bond rating, from Moody’s Investors Service, which rates the city Ba1 with a stable outlook. Fitch Ratings rates Chicago BBB-minus and stable.
Chicago’s yield penalties sharply narrowed to a 170 basis point spread in a March sale from a high in an early 2017 GO sale of a comparable 331 bp spread over Municipal Market Data’s AAA benchmark. Secondary spreads have further narrowed and are about a 140 bp spread, said MMD-Refinitiv senior market strategist Daniel Berger.
IHS Markit strategist Edward Lee observed a trade last week at a 135 bps spread down from a prior spread of 148 bps. The administration will host investors at an annual investors’ conference Sept. 20.