Mounting Debt Weighs Down Chicago Balance Sheet

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CHICAGO – The long-term principal and interest payment schedule for Chicago's general obligation debt swelled by about $1.7 billion last year as Mayor Rahm Emanuel and his finance team scrambled to fix a downgrade-driven liquidity quagmire that threatened the city's balance sheet.

"I think it was still important and the right thing to do" to mitigate the city's exposure to banks, chief financial officer Carole Brown said in an interview. "We were facing a real liquidity crunch," and debt conversions and restructurings that added to the city's debt load represented the "right thing to do for the health of the city."

City debt figures are among the mixed financial data from 2015 that will greet attendees of the city's annual investor conference Aug. 3.

The city published its 2015 comprehensive annual financial report on Friday offering the market a look-back at recent results. The administration's annual financial analysis that's released later this month will look ahead, revealing the gap that must be closed ahead of the fall release of a 2017 budget as well as multi-year projections based on various revenue scenarios.

The city has made strides in chipping away at its structural budget deficit and better funding several of its pension funds -- primarily through tax hikes -- but its net position for reporting purposes has deteriorated. The city's ending balance strengthened, allowing the administration to make good on a pledge to rely less on debt for operations.

The city resolved a potential liquidity crisis triggered by Moody's Investors Service's junking of the city's GO rating and lowering of water and wastewater bonds in the spring of 2015, but the solution added significantly to the city's taxpayer supported debt burden.

"The good news is we're taking action, that's a positive and a change in Chicago," said Brian Battle, director of trading at Performance Trust Capital Partners. The bad news, he said, is that the city is captive to the state's budget struggles and political gridlock. The city needs state approval for further pension funding changes and could lose out on its share of income tax revenue and other funds as part of a state budget solution, he added.

"We are a long way from the finish line," said Richard Ciccarone, president of Merritt Research Services.

Debt Overview
The city closed out 2015 on the hook for $17 billion in GO debt payments through 2043, with $9 billion due on principal and $8 billion on interest, after paying off $236 million in principal and $438 million in interest during the year.

A year earlier, the city closed the year owing $8.3 billion in principal and $7 billion in interest, for $15.3 billion.

The larger figures reflect about $1 billion in new money issuance Chicago sold in July 2015 that was characterized as a "clean-up" deal to resolve liquidity woes and provide budget relief.

The Moody's downgrades in May 2015 triggered termination and default events on swaps and credit support for floating-rate and credit lines that could have accelerated $2.2 billion in city debt repayments.

Market participants characterized the "clean-up" description as a good one given that the city swept so many operating costs into the deal to relieve general fund pressures.

It converted into long-term debt $677 million of debt in the city's short-term borrowing program because credit support was in default due to the GO downgrades. The line had been tapped to cover swap termination fees, some of the cost of converting floating rate GOs, judgments and bank fees due to downgrades. Another $180 million went to cancel a 2005 leveraged lease transaction involving a rapid rail transit line and the deal capitalized $170 million of interest.

Just under $100 million of the credit line debt being retired had funded capital projects, Brown said.

The city paid interest rates of between 5% and 7.75% on the tax-exempt and taxable paper, with respective spreads of about 250 basis points and nearly 500 basis points. The city fared about 20 basis points better in a sale earlier this year.

"Our hope is that as we cleanup our financials and close the structural deficit our spreads will start to narrow," Brown said.

In addition to the GOs, the city converted about $700 million of floating-rate GOs to a fixed rate to shed bank credit support that was in default last year. That added to interest costs.

The city's debt schedule faces growth with a planned $1.25 billion sale. About half will go to fund capital projects. The city is eyeing a traditional refunding for savings that can be achieved despite its steep spreads because of the record low rates prevailing in the municipal market.

But the deal also includes the final years of scoop-and-toss debt restructuring before being phased out in 2019, including $100 million for 2016, $100 million for 2017, and $125 million for 2018.

The city pushed off principal payments coming due for budgetary relief in amounts between $90 million and $170 million beginning in 2007 under then Mayor Richard Daley. Emanuel took office in 2011.

On the revenue bond side, the city converted about $330 million of wastewater bonds and sold $87 million to cancel swaps and converted $112 million of sales tax bonds. It also sold $1.9 billion of O'Hare International Airport debt and $76 million of O'Hare commercial paper.

As part of the conversions and restructuring, the city shed nearly all its interest rate swaps with only Midway Airport-related swaps tied to $135 million of debt remaining.

Investors will be watching closely to see whether the city "is able to stay the course on the promises they've made to investors" about debt practices and aligning revenues with expenses, Ciccarone said.

The city's $9 billion of GO debt, combined with the $10.4 billion issued by Cook County, Chicago Public Schools, Chicago Park District, and others bring the total overlapping burden to $19.4 billion for a debt per capita figure of $7,211.

That's up from $18.5 billion and debt per capita of $6,845 in 2014 and $13.2 billion and debt per capita of $4,548 in 2006.

Ciccarone said the woes of CPS, despite additional help approved by state lawmakers to help the system tackle a $1 billion deficit, looms large for investors and will further strain the tax base. Lawmakers gave the district room to impose an additional $250 million in property taxes.

The city ended 2015 with $240 million outstanding on credit lines that expire in 2017, paying a 5.43% interest rate. The city currently has about $144 million outstanding. The city earlier this year raised its credit line capacity to $900 million from $750 million.

In addition to its GOs, the city closed out 2015 with $212 million of motor fuel tax-backed bonds, $542 million of sales tax bonds, $65 million of tax increment financing bonds, and $13 billion of enterprise fund debt for operations like its airports.

The city has sales tax and water and wastewater deals still slated for this year and will soon introduce to the city council an O'Hare International Airport refunding, Brown said.

The city's net pension liability totaled $33.9 billion, according to the CAFR. The figure includes $18.6 billion of municipal employees' fund liabilities, $2.5 billion of laborers' fund liabilities, $9 billion of police fund liabilities, and $3.8 billion of firefighter fund obligations.

The 2015 CAFR marks the first reporting on the figure based on actuarial reports from its four funds applying new Governmental Accounting Standards Board calculations for reporting purposes.

The new rules require changes in the discount rate used in calculations and a shorter amortization schedule. The changes separate pension liability accounting and reporting from funding which is reflected in the unfunded liability figures. The net pension liability figure also must now be recognized on the fund and employer's balance sheets.

The changes do not impact funding or the size of the actuarially accrued unfunded liabilities which were at about $20 billion at the end of 2014.

While most market participants expected the tab to be substantial, Ciccarone said the number is still sobering. "It provides a more vivid picture of the unfunded scale and scope of the liabilities and how they weigh down the balance sheet," he said.

The net police and fire figures are expected to worsen next year as the funds factor in changes recently approved by the General Assembly delaying a shift to an actuarial required contribution and extending deadline for reaching a 90 % funded ratio.

If the city's proposed restructuring of the laborers' fund is approved by state lawmakers, the net liability for that fund could improve. Brown said the city will unveil a municipal employees' fund fix this summer.

Other Data
The city closed out 2015 with a total fund balance of $215 million, up from $150 million a year earlier. It used a portion to cover operating expenses like judgments and union settlements, leaving an unassigned balance of $93 million.

"For us that really demonstrates that belt tightening is working," Brown said.

The city continued to chip away at its other-post employment benefits, reducing its unfunded liability to $781 million from $965 million as it phases out most retiree healthcare subsidies. The catch is a pending court challenge to the city's move.

The city's net position of the governmental activities declined by $15 billion to a negative $24 billion primarily because of the size of the newly calculated net pension liabilities.

The city said it did not include in past annual budgets the full amounts needed to finance future liabilities of $29 billion arising from municipal employees', laborers', police and firefighters' net pension obligation and other post-employment benefits of $29 billion.

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