In a late at-bat, Emanuel takes a swing for a pension obligation bond deal
CHICAGO — Chicago would issue up to $10 billion of pension obligation bonds under a proposal Mayor Rahm Emanuel unveiled Wednesday.
Emanuel, who isn't running for a third term, is leaving the proposal to City Council members to embrace or reject.
The ordinance would lay the legal groundwork for the borrowing while aides said it would likely fall to his successor to complete unless the council moves quickly. The actual bond financing would need to be introduced later, leaving it to the council to decide if it wants to move forward before Emanuel leaves office in May or let his successor deal with Chicago's pension funding needs.
“This proposal requires thorough analysis and the time everyone needs to fully understand it and ask the necessary questions. That is why this ordinance is just the first step of a two-step process. The next step would require an additional level of council approval to actually issue the bonds,” Emanuel said in a long-planned address that had been billed as a review of progress made on solving the city’s pension crisis and presentation of ideas to further stabilize the four-fund system.
“If the next council and next mayor want to take a different approach, it goes away,” with the ordinance expiring at the end of 2019, he said.
“I would add one caution that there is not an endless amount of time. Interest rates have been going up. The Fed Chairman has indicated they will hold steady, but we do not know for how long that will be the case,” he said. “There is a window in the market today for this to work. At some point that window will close. “
Emanuel’s ordinance would establish the Dedicated Tax Securitization Corporation, modeled after the bankruptcy-remote Sales Tax Securitization Corp. entity which the city established last year to refund $3 billion sales tax and general obligation bonds.
The new special entity, allowed under 2017 state legislation the city crafted that allows local home rule units of government to securitize tax revenue that flows through the state, would issue up to $7.7 billion of bonds.
The DTSC would purchase the city’s share of state income tax collections, personal property replacement taxes, and residual sales tax revenues not needed to repay the city’s sales tax securitization bonds.
The ordinance also provides the framework for the city to sell a more traditional revenue bond in the form of $2.3 billion of Water and Sewer Excise Tax Receipt revenue bonds. The tax was previously approved by the council to fund a ramp up in contributions to the municipal employees’ fund. Going forward, those revenues would secure the bonds and the bond proceeds would go to the municipal fund.
“The adoption by City Council of a subsequent ordinance authorizing the sale of bonds is required prior to the issuance of any fund stabilization bonds,” a statement says. “The bonds would be structured to have a stronger rating than the city’s general obligation credit, expected ratings in the ‘A’ range.”
The ordinance would mandate that all bond proceeds go to “make large one‐time deposits into the city’s pension funds; to establish stabilization accounts for the benefit of the pension funds; and to pay certain costs of issuance.”
The bonds would trim $6 billion to $7 billion off future city contributions needed to reach a 90% funded ratio in 2055 for two funds, and 2058 for the other two. The city is aiming to borrow in the 5% to 6% range while its pays at least 7% on the unfunded liability based on the funds’ current discount rates. The funds have long earned at least 8% on its investments, Emanuel said.
“I know this plan has risk. The truth is, there is risk in every choice and there is a risk if you do nothing. The question is: which calculated risk is worth taking for the benefit gained?” Emanuel said. “If you raise taxes too high you risk that businesses will not come to Chicago and you risk adversely affecting the overall health of the economy.”
The infusion of cash would raise the pension funds to a more than 50% funded ratio from a current collective ratio of 26.5%. Under the current funding schedules that ramp up to an actuarial level, the city must come up with an additional $276 million in its 2020 budget for its police and firefighter funds and $310 million for its municipal and laborers’ funds in 2022.
The bond issue would cut the 2020 payment to $76 million.
Council members are straining to avoid new taxes to meet the funding requirements after signing off during Emanuel’s second term on a property tax hike to raise $543 million for public safety funds, a water-sewer excise tax that raised $240 million for the municipal fund and 9-1-1 fee that raised $40 million for the laborers' fund. The taxes were part of the mayor’s revised overhauls after the state’s high court shot down plans that cut benefits.
The funding overhaul now in statute saved the municipal fund from exhausting assets in 2024 and the laborers’ fund in 2026.
The new securitization, which like the sales tax structure would provide a lockbox on revenues that bypass city coffers to insulate them from the risk of future city distress, would divert a good chunk of revenue that now flows to the city’s corporate or general fund.
Chicago’s chief financial officer, Carole Brown, said the corporate fund wouldn’t actually see a loss.
“What we would propose to be doing is a swap with the corporate fund so we wouldn’t actually be cannibalizing a penny of corporate fund revenue because we are not going to need all of that property tax revenue” after having “dumped a bunch of money into the pension funds,” Brown said. “We would just do a dollar-for-dollar swap.”
A vote on the introduced ordinance introduced Wednesday could come in January, Brown said.
“We would put the structure in place. We would have it all set to go but if there were a desire for council to proceed we could do a second ordinance” on the financing, Brown said. The financing could be introduced in January and approved as soon as March if an agreement is reached so it’s not “100% certain” that the borrowing plan would be left to his successor to complete.
The administration has publicly been exploring a $10 billion POB since Aug. 2 when it was pitched by mayoral advisor Michael Sacks at the city’s investors’ conference.
The deal at first appeared on a fast track with council members saying they heard it was to be introduced in late September, creating speculation that Emanuel would ram it through without proper vetting.
Emanuel’s announcement after Labor Day that he would not run again threw a wrench in the deal planning.
Treasury rates also rose in the interim raising more questions over how successful of an arbitrage play between the bonds’ interest rates and potential investment earnings the city could achieve.
Treasury rates have now returned to rates on par, or better, than those when the city first pitched the idea in August. Any POB would be taxable and so priced off Treasuries. The 10-year on Monday was at 2.85% compared to 2.98% where it stood in early August before rising to 3.09% Oct. 1 and peaking at 3.24% on Nov. 8.
The bonds are part of a larger package of ideas Emanuel pitched Wednesday to help mend the city’s pension funding shortcomings, which have dragged its ratings down. City general obligation bonds carry a junk rating from Moody's Investors Service, triple-B category ratings from S&P Global Ratings and Fitch Ratings, and single-A territory ratings from Kroll Bond Rating Agency.
Emanuel said he would also lobby for a state constitutional amendment that would ease the staunch protections of benefits from impairment and diminishment to allow for some reforms, such as ending an automatic compounded cost-of-living increase. Such a measure is considered a longshot with the General Assembly’s Democratic majorities and incoming Democratic governor opposed given labor’s opposition.
He will also press for the city to share in revenue from the expected legalization next year of recreational marijuana and will push for the city to raise its own revenue by establishing a home rule taxing authority. The mayor will also back a new gambling expansion bill in the works that would allow for a Chicago casino. Funds from the two revenue sources would go to pensions although existing pension legislation already requires any casino profits go to city pensions.
The mayor’s proposal to direct other potential revenues to the pension funds and to pursue a constitutional amendment could help ease some of the criticisms leveled by some municipal market participants after the investors’ conference. They warned of the difficulty in swallowing pension bonds without a broader, long-term plan package.
Three institutional investors who hold both the city’s GOs and sales tax securitization bonds attended Wednesday's speech and in an interview all said they “were cautiously optimistic” while one noted that the “devil is in the details.”
Other critics are not likely to be swayed given the arbitrage risks and potential ratings risks and impact on the value of Chicago GO bonds. The Government Finance Officers Associations recommends against using POBs and S&P has warned that depending on the structure of the POBs and whether or not the city would make changes to its pension funding discipline, issuance could have rating implications for Chicago.