Chicago readies arguments on fiscal gains as investors hit town

CHICAGO – Chicago will work to sell more than 200 investors Thursday on the evidence it says shows that its finances are on the mend, that its school district is on firmer fiscal and academic footing, and that it’s implementing strategies to combat violent crime.

The annual conference follows the release of fresh financial data that provides both a look back at 2017 in the comprehensive annual financial report published last month and ahead at 2019 and beyond in the 130-page annual financial analysis published Tuesday.

Both display fiscal inroads the city has made even as the weight of pensions and other obligations strain its finances.

The new review projects a structural budget gap of $98 million next year, the lowest since 2008 and down from $635 million when Mayor Rahm Emanuel took office in 2011. Bigger projected gaps loom as do pressures from potential public safety and personnel costs not yet fully accounted for and future hikes in pension funding as actuarial-based contributions hit under the city’s new funding plans.

Chicago's chief financial officer, Carole Brown, accepts theFreda Johnson Award for Trailblazing Women in Public Finance at The Bond Buyer Deal of the Year event in New York on Dec. 6, 2017.

The city plans to remind investors “where we began and the progress we’ve made and we will give them a little insight into what’s on tap,” said Carole Brown, the city’s chief financial officer since 2015, as her boss seeks a third term next year. “Pensions are still the No. 1 thing we are asked about.”

The gap has been cut, ending balances and reserves improved, frowned-upon debt practices like scoop-and-toss restructuring have been shed, and new pension funding schemes are in place. The latter drove positive credit action and staved off insolvency for two funds. With an infusion of new state funding CPS has garnered rating upgrades.

Casting a shadow over the city’s balance sheet is the slog toward improving pension funding ratios that slipped last year, big leaps ahead in contribution levels, and one rating stuck in junk. For the district, a primary strain is its reliance on $1 billion of costly short-term borrowing and the black mark of three junk bond ratings.

The pension burden has kept the city’s rating from Moody’s Investors Service at junk level since 2015, although the rating service did last month revise the city’s outlook to stable from negative in recognition of the pension funding commitment.

“We are going to take an objective and hard look at the question of whether or not the city has made progress,” Brown said in an interview along with budget director Samantha Fields on Tuesday. “We are not running from that question. We know there is work to be done.”

Brown takes the position that the city is being shortchanged in terms of rating and borrowing costs given its fiscal gains. Where the city's finances stand will be the subject of a panel discussion moderated by James Reynolds, chief executive officer of Chicago-based broker-dealer Loop Capital Markets LLC’. Panelists include Emanuel's advisor Michael Sacks, CEO of Chicago-based Grosvenor Capital Management, and Richard Ciccarone, president of Merritt Research Services LLC.

In addition to pensions, Chicago's image as a "war zone" mired in violent crime and police shootings has weighed on investor sentiment, prompting the city to put public safety on the agenda for the first time.

Chicago Police Department Superintendent Eddie Johnson will speak on city strategies and a tour of the department strategic decision support center is on tap. That’s in addition to the city’s main water plant, the Chicago River to highlight development, and O’Hare International Airport.

“The ultimate goal is to have the market perception of the city of Chicago reflect the true financial condition of Chicago,” said Brown, who contends the city’s ratings and spreads don’t fully recognize the city’s improved structural position.

In addition to the Moody’s outlook change, the city won a two-notch upgrade to A from Kroll Bond Rating Agency this year. Its spreads have narrowed with a 2035 maturity with a 2019 call trading this week at about 160 basis points to the AAA benchmark scale, according to data provided by IHS Markit’s Edward Lee. The city’s spreads were around 230 basis points a year ago this time.

Fitch Ratings has the city’s general obligation debt at BBB-minus with a stable outlook and S&P Global Ratings has it at BBB-plus with a stable outlook. Both shifted the outlook from negative in 2016. The single A 10-year benchmark spread is at 47 basis points and the BBB is at 82 basis points, so the city’s spreads are much wider.

Speakers include Emanuel and schools chief Janice Jackson, who will deliver the keynote to highlight academic gains.

Tax increases are not currently on the table to wipe out the $98 million gap in an estimated $3.7 billion corporate or general fund.

“We think the gap is manageable and we can do it through the normal budget process” that includes whittling down expenses through management efficiency, Brown said.

The gap could widen due to police reform measures under a consent decree announced last week by Emanuel and Illinois Attorney General Lisa Madigan. The price tag is not yet known as the deal is not yet final, and negotiations are also still in progress on labor contracts that could drive up personnel costs in 2019.

Judgments and legal claims, budgeted at $45 million, have cost Chicago more than $70 million so far this year. The city has no current plans to return to its past practice of borrowing to cover judgments, Fields said.

Under a base outlook, a structural deficit of $251 million and $362.2 million are projected in 2020 and 2021, respectively. Under the negative outlook, the shortfall would grow to $647 million in 2020 and $860 million in 2021. The positive outlook, the shortfalls would be $108 million and $170 million.

Other variables that could affect revenue and expenses include local and state elections, such as the November gubernatorial contest, and the economic climate. In addition to the mayoral race, council members are up for re-election.

A $20.2 million surplus is expected this year after stronger-than-expected revenue growth and a decline in projected personnel costs.

The city’s net pension liabilities for reporting purposes — based on accounting rules that take into account various actuarial factors — dropped to $28 billion from $35.8 billion as the city enacted funding schemes to stave off the insolvency of two funds, resulting in discount rate changes.

The city’s unfunded liabilities — which look solely at the difference between liabilities and assets — illustrate the weight of the burden. Unfunded obligations grew to $27.6 billion in 2017 from $25.5 billion in 2016 with the funded ratio eroding to 26.5% from 28.1%.

Contributions topped $1 billion last year, but still only represented 42% of the actuarially required contribution.

They total $1.18 billion next year and jump to $1.67 billion in 2021 as actuarial funding hits for police and fire and then $2.1 billion in 2023 when municipal/laborers' hit actuarial funding levels.

Payments reach $5.9 billion in 2055 as police and fire hit a 90% funded ratio. The other two hit 90% in 2058. The funded ratio doesn’t hit 30% until 2029 and a 50% ratio isn’t achieved until 2047. The city faces a diversion of its state grants if it doesn’t honor pension funding requirements.

A phased-in $550 million property tax hike is covering the ramp up period for police and fire, a water-sewer charge on the municipal fund, and an emergency 9-1-1 fee covers the small laborers’ fund increased contributions. The city is not showing its hand on how it will fully cover the higher payments.

“It’s not a small amount of money but we’ve shown our ability” to cover the current increases in a way that doesn’t hurt economic growth and allows for new investments in some areas, Brown said.

The city’s unassigned fund balance grew to $155 million last year from $34 million in 2013.

Payments on the city’s current $24.5 billion debt portfolio rises next year to $2 billion – including $659 million for property tax supported GOs – from $1.9 billion this year – which included $538 million for property tax supported GOs.

GO debt service growth has slowed as GOs are being refunded through the city’s new Sales Tax Securitization Corp. The past use of scoop and toss restructuring had previously held down the growing costs of GO debt service.

For the first time since Emanuel’s former CFO Lois Scott launched the conference, it is open to the press. In the past, the city only allowed coverage of Emanuel’s speech.

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