Chicago nears a decision on pension obligation bonds
CHICAGO — Chicago’s fiscal chief expects to decide in the “next week or so” whether to recommend if the city should sell up to $10 billion of pension obligation bonds to improve funded ratios and ease — but not eliminate — the taxpayer burden of looming payment spikes.
On Tuesday, Chief Financial Officer Carole Brown said if she believes a financing would meet the city’s goals, and Mayor Rahm Emanuel agrees, the administration would need to determine how best to present it to the City Council, which would vet the financing structure and team.
If the deal is a go, Brown said from a financial management standpoint she would prefer to get into the market by the end of year given favorable market conditions with demand exceeding supply, whereas waiting longer would bring more uncertainty about interest rates and demand further out with the Fed expected to keep raising the federal funds rate.
“I always want to be in the market when I like the market,” and don’t like trying “to guess what it looks like in six months or a year,” Brown said. “If I could be in today I would be in today,” given current market conditions. “The recommendation would be to schedule before the end of the year.”
Brown first disclosed that her finance team was taking a “hard look” at the feasibility of a pension bond financing after mayoral advisor Michael Sacks pitched the idea of a securitization during a panel discussion Aug. 2 at the Chicago investors’ conference.
If the city proceeds, it expects to come to market with a single transaction, Brown said Tuesday. She cautioned that the size is still to be determined if she recommends that the city move forward.
The city is saddled with a $28 billion unfunded pension liability tab with its four funds collectively funded at just 26.5%, and they won’t see material improvement for several decades even with the additional funding the city has so far approved.
The city will contribute $1.18 billion next year, rising to $1.67 billion in 2021 as actuarial funding requirements hit for two funds and then $2.1 billion in 2023 when the two other funds are required to receive actuarially based payments. The city has raised property taxes, enacted a water utility charge, and 9-1-1 fee to fund higher payments, but has not said how it will tackle the upcoming funding spikes.
The borrowing could ease that spike but more revenue will still be needed.
“We are not able to create a structure that will eliminate the need to raise revenue additional revenue,” Brown said. “What we are evaluating is ‘is there a structure that can reduce the cost of our unfunded liability and lower the cost to taxpayers?’”
Market participants have offered mixed assessments, with some saying the city’s pension obligations are so burdensome that all ideas should be on the table and that the immediate infusion of revenue would provide a long-term benefit.
Other have panned the idea and warned POBs are too risky over the long term and could damage the city’s fiscal progress. The Government Finance Officers Association recommends against their use.
The latest attack came from 2019 mayoral contender Paul Vallas, who on Tuesday called the possible deal a “financial boondoggle.” He called on the City Council to invoke privatization deal rules that would freeze any action for 60 days and require public hearings and an independent assessment.
Brown called Vallas’ attack “premature” since a deal is still being evaluated.
In response to criticisms leveled by Vallas and some market participants, Brown said Chicago isn’t interested in coming to market with a pension obligation bond issue that doesn’t improve the city’s overall fiscal health. Chicago’s general obligation ratings range from junk — because of the pension burden — to single-A.
“The mayor has been clear” in dedicating his second term to stabilizing the city’s fiscal foundation, Brown said. “If I make a recommendation to proceed it’s because we have figured out a structure that is beneficial to the city.”
A common thread in comments has been the suggestion that the city should tread cautiously in sizing and structuring any deal balancing the need to attract investors with an airtight security against protecting against long-term balance sheet damage by siphoning off existing revenues.
If the city uses a securitization structure, it will strip more funds from its $3.7 billion corporate fund, potentially damaging the value for existing GO holders, some say, and should the city end up in a distressed situation pension bondholders would hold a stronger position over others.
“I don’t understand how, if we have lowered the cost and risk associated with our pension debt, how that is not accretive to my GO” value, Brown said. “If we ever present a financing plan, that financing plan will be viewed as a positive to our overall financial position.”
Pension bond critics warn that even though the city would lower future costs by reducing the unfunded liability immediately, it’s at risk of adding to its long-term costs if earnings on its pension investments don’t exceed the bond interest rates. The city will also have traded a more flexible liability for a hard one with more severe consequences in the event of a default.
Brown counters that the “courts, the legislature, the rating agencies, and investors have told us they view the city’s pension debt” as a hard, long-term liability similar to the city’s $10 billion of GO debt, so “to not try and address” the pension debt and potentially lower it “in a cost-effective and efficient way would be irresponsible. If I do nothing I still have the risk of performance and investment returns.”
Comparisons have also been made to Illinois’ $10 billion 2003 pension bond deal that only temporarily brought up funded ratios — to 60.9% from 48.6%. They are now at 39.9% and the unfunded tab tops $100 billion compared to $38 billion in fiscal 2005.
Brown said the city’s deal would be different in that proceeds would be invested “to benefit the funds” while “the state used a portion for [budget] relief.”
The state used $2.7 billion to cover near-term contributions.
The city's upcoming actuarial funding requirements are codified in state law.
The state government, in contrast, makes pension payments are based on a 1995 funding schedule that falls short of reaching actuarial contributions.
The size of any deal remains subject to a review of “capacity,” Brown said. She appears to be leaning toward the use of its securitization structure as the bankruptcy-remote structure of its special entity and statutory lien on pledged revenues that flow from the state offer high-grade ratings and stronger investor appeal.
The city can redirect revenues it receives from the state to a special entity under the securitization program approved by state lawmakers last summer at the city’s behest.
“We are balancing wanting to be impactful to the funds” in a way will “move the needle” with the available capacity of dedicated revenue, she said. “Capacity will influence size,” Brown said.
The city already leveraged much of its sales tax flow. Other available revenues include its local distributive share of state income taxes that totaled $240 million last year, $148 million of personal property replacement tax revenue, and $54 million of motor fuel revenues. Some revenue streams are subject to the whim of the state, such as the level of shared income taxes.
The city is “looking at existing revenues” and not eyeing the securitization of a new revenue stream which could require some state action.
If the city proceeds, the financing team would be selected from the existing ranks of firms that have submitted their qualifications to work on city deals. Brown said the city has sought out input from some market “professionals,” but she declined to name the firms.
Vallas attacked the pension borrowing from multiple angles. “On its face this $10 billion pension obligation bond proposal appears to be a terrible financial gamble,” Vallas said.
While Brown said she was just exploring the idea and no decision had been made, Vallas said he has “been getting reports from a number of sources indicating the Emanuel administration is trying to rush this highly speculative borrowing scheme through the City Council.”
“Pension obligation bonds will further straitjacket the city’s ability to deal with any future economic downturn,” he said. “The city is effectively mortgaging more and more of its financial future.”
The borrowing would allow Emanuel to kick the financial can past next year's city election and allow him to “shower his Wall Street backers with a fire hose of underwriting and legal fees,” Vallas said.
Vallas did stints as Chicago’s revenue director and budget director under Mayor Richard Daley and led the Chicago Public Schools in the mid-1990s. Emanuel is facing a handful of candidates in the Feb. 26 contest. If no candidate receives a majority of votes, a runoff election will follow April 2.
A pension bond deal would join a crowded Chicago primary market slate. The city will offer a third tranche of its sales tax securitization bonds in October and has plans to sell water and wastewater revenue bonds sales, and roughly $1.5 billion to $2 billion of O’Hare International Airport revenue bonds.