CHICAGO — Chicago is mulling the “feasibility” of a pension financing in an effort to stabilize the funds, bolster ratings and lower borrowing costs as market participants fret over poor funded ratios and looming contribution leaps.
The city is exploring the “feasibility of financing as an option to further stabilize our pension funds,” Chicago’s chief financial officer Carole Brown said in an interview with reporters after the city’s annual investors conference Thursday.
The city’s four pension funds are collectively just 26.5% funded, with the net pension liability tab at $28 billion. The city is phasing in higher payments to reach an actuarial based payment level. It will take nearly three decades just to achieve a 50% funded ratio.
“If there was a way that we can address those issues — address the issues of everyone worrying about the cliff, the high cost of our pension debt, and stabilize the funds … it would be irresponsible for us not to analyze and consider it and recommend or dismiss it,” Brown said.
The finance team is “taking a really serious hard look at it” but is not yet recommending “that we pursue it,” Brown said. Security and structural options are all on the table and Brown said she could not yet put a size on what the city might consider. “I haven’t concluded that it’s something that for a variety of reasons would make sense.”
The Government Finance Officers Association recommends against the use of pension obligation bonds. Several recent Chapter 9 cases have cast a pall over POBs as investors suffered greater losses than pensioners did and some analysts have suggested that POBs contribute to distress. Chicago’s use of its securitization structure would give bondholders more protection.
Brown said a year ago she would have discarded the financing option, but now the city has pension funding legislation in place, supported by new tax revenue, has gained ground in areas like the structural gap and reserves, and has seen some positive credit momentum in an upgrade from Kroll Bond Rating Agency and an outlook change to a stable from negative from Moody’s Investors Service. Moody’s is the one agency that rates Chicago at a junk level (Ba1).
“I’m at a point where I feel like we need to look at it seriously and see whether or not there is a financing plan that would meet the kinds of objectives that the mayor would have, that our council would have, that the rating agencies would have,” she said. “I just don’t know the answer to all that.”
The city could consider a traditional pension obligation bond or a securitization that taps the Chicago-authored 2017 state law allowing home rule units of government to securitize state collected tax revenues through a bankruptcy-remote special purpose entity.
“We have to do it in the most cost-effective way possible and right now our most cost-effective security is our securitization security,” Brown said.
The city last year established the Sales Tax Securitization Corp. and the City Council has approved up to $3 billion in sales tax and general obligation refundings. The city issued $704 million last year, $680 earlier this year, and has plans this fall to sell $750 million.
Other revenues, like the city’s share of local government shared revenue and personal property replacement and motor fuel taxes, could be leveraged. Critics have said diverting those revenues from the corporate fund damages GO value.
Due to its bankruptcy-remote status and other features like a statutory lien, the paper carries a AA rating from S&P Global Ratings and AAA ratings from Fitch Ratings and Kroll. The city’s GOs are rated BBB-minus by Fitch, BBB-plus by S&P, and A by Kroll.
Further use of the state law would require the city to either broaden the powers of its STSC or establish a new entity.
Brown was questioned about a potential financing after a panel discussion on the condition of city finances that included Richard Ciccarone, president of Merritt Research Services LLC, and Michael Sacks, chief executive officer of GCM Grosvenor, who is a close ally and economic adviser to Mayor Rahm Emanuel
Sacks raised the specter of a $10 billion securitization leveraging $949 billion in city revenue that goes to fund pension contributions, suggesting it would provide 1.4 times coverage at a 5.25% interest rate, although the city would pay more for a taxable POB.
“I’m not saying it’s right, I’m not saying it’s not right. I’m just making a point,” he said. “Future increases for pensions become manageable” and the pension cliff “hysteria” is shed and funded ratios land north of 50%.
Sacks' suggestion surprised investors and bankers alike. “It was designed to start the conversation,” said one institutional investor who asked not to be identified.
On how a pension financing would fare with investors, another buyside representative said, “it will depend on the structure and size and the security and coverage and whether it’s part of a comprehensive plan, not just something that covers increasing payments.”
City contributions will 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.
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 is seeking to quell the persistent focus on its deep pension woes despite funding progress. After the Illinois Supreme Court ruled against the city and state on pension reforms making clear that any benefit cuts violate the state constitution, the city adopted new plans that bolster the funds primarily through higher contributions.
A five-year ramp up of increased contributions will alloow the city to reach actuarial levels in 2020 for police and firefighters and in 2022 for the municipal and laborers’ funds.
Emanuel, who is running for a third term next year, pushed through a record, phased-in $550 million property hike to fund the police and fire fund, a water-sewer charge to fund the municipal fund, and a 9-1-1 surcharge to fund the laborers’ hike.
The city has not shown its hand on how it will cover the jump in payments after an actuarial payment hit. More tax hikes face a tough political road and the city has sought to stress that with its structural gap down to less than $100 million, from more than $600 million when Emanuel took office in 2011, it’s better positioned to absorb the future costs.
Several investors said the city’s timing is good as the high-yield market is starved for paper. While a pension borrowing would solve some of the city’s problems, it is also fraught with uncertainties given the potential impact on ratings and questions over investor appetite for a potentially large offering.
There’s also the gamble posed by the arbitrage play given that borrowing rates remain low but the proceeds would be invested in an expensive equities market with the risk that future returns won’t exceed the bonds' interest.
The city’s tax-exempt GOs are trading at about a 160 basis point spread to the top-rated benchmark. It has not sold GOs since early last year. Its taxable securitization bonds sold at an 87.5 basis point spread to comparable Treasuries and its tax-exempts have sold at 26- to 61 basis point spreads to the benchmark on the tax-exempts.