Muni market awaits action as Lightfoot takes reins in Chicago
Chicago’s new mayor and her finance team have officially begun their deep dive into the city’s books as they confront the city's deep fiscal woes.
The steps Lori Lightfoot settles on stand to influence the city’s low bond ratings and high borrowing rates.
Lightfoot, a corporate lawyer who led the Chicago Police Board, took the oath of office Monday and faces decisions soon about how to cover rising contributions toward $28 billion of unfunded pension liabilities along with rising debt service and labor costs.
Lightfoot listed the city’s long-term fiscal stability as a top priority along with strengthening public education, instilling government integrity through ethics reforms, and improving public safety.
She is, for now, still leaving the market waiting when it comes to fiscal answers.
“We have an outsize structural deficit, a persistent and growing pension debt, and other costs that threaten our financial stability,” Lightfoot said in her inaugural address.
She said her team has been working to measure the “size and depth” of the challenges and is looking at a range of possible solutions but only when the analysis is complete will she “lay out a plan to put Chicago on the path to solvency.” The city operates on a $10.7 billion budget.
Most recently the operating deficit was tagged by the outgoing administration at more than $700 million, not including a persistent structural imbalance that last summer was projected at $250 million. Lightfoot, who made history by becoming the first black woman to win the mayor’s office and the first who is openly gay, has warned it’s worse than $700 million.
Chicago Public Schools finance chief Jennie Huang Bennett will lead the charge as the city’s chief financial officer with city hall budget veteran Susie Park as budget director.
Lightfoot inherits one junk-bond rating but Moody’s Investors Service last summer did revise its outlook on the Ba1 rating to stable from negative. Kroll Bond Rating Agency last year raised the city’s rating two notches to A. S&P Global Ratings rates the city BBB-plus and stable and Fitch Ratings rates its BBB-minus and stable.
Chicago’s primary spread penalties peaked in its early 2017 GO sale when a 12-year bond in the deal landed at a 331 basis point spread over Municipal Market Data’s AAA benchmark. As the city made progress on its budget, raised pension contributions, and shed poor borrowing practices, the market rewarded it by cutting spreads down to 170 bps on mid-range maturities in its March sale.
Chicago GO bonds have been trading around a 160 bp spread to the AAA scale, said Daniel Berger, senior municipal strategist at Refinitiv MMD. IHS Markit said Chicago trading was quiet Monday but strategist Ed Lee said he observed a recent trade on a 2044 bond with a 5% coupon at 165 bps above the triple-A benchmark.
THE BOND MARKET
“There’s never been a tax increase the market didn’t like,” but that can’t be the only answer especially given the tax fatigue after recent city hikes and amid new and higher taxes being proposed at the state level, said Richard Ciccarone, president of Merritt Research Services LLC.
Lightfoot needs to tread cautiously so as not to disrupt the city’s economy.
“Whatever the gap, whether it’s $700 million or $1 billion, she has to show sensitivity to those factors,” Ciccarone said.
Ciccarone counseled the new mayor against any effort to delay pension contributions and to remember Chicago’s status as a global city where every action she takes will be watched by not just the public but investors in the city’s debt.
“She needs to provide a vision as well as a plan of attack,” Ciccarone said. “I would love to see her come out” with a plan and say that the goal is to earn 'A' ratings, he said.
Investors want city to keep up its buy side outreach, including annual investor conferences launched under Emanuel.
The bond market wants to see that “lines of communication are open. That’s critically important,” said Howard Cure, director of municipal bond credit research for Evercore Wealth Management. Cure is watching for the city’s position on Chicago Public Schools’ future and borrowing practices like the use of the city’s sales tax securitization structure.
The new CFO, who holds a public finance banking and government finance management background, may exhibit a “sensitivity to what bondholders and institutional investors and analysts are looking for” but the “bigger question is how much guidance will the new mayor accept,” Cure said.
Lightfoot’s campaign platform favoring reform on policing and aldermanic privilege could help smooth the way for tax hikes.
“To the extent that she can improve…..trust in city government that in itself could prove successful for the city as it tries to carve out its fiscal path, particularly when we are talking about raising taxes. Having trust in city government is a key component,” S&P Global Ratings’ lead Chicago analyst Carol Spain said at the rating agency’s state and local government credit forum in Chicago last week.
The city has little room to maneuver on pensions in any way that doesn’t raise funding levels or funded ratios because the current funding schedule that moves to an actuarial level over the next few years doesn’t even begin to amortize the unfunded liability for two decades.
That’s “weak and risky for a well-funded plan,” let alone one like Chicago that is so weak and represents a “dangerous place to be” especially because the current plan doesn’t take into account downside investment return risks, S&P pension analyst Todd Tauzer said at the forum. The funds are collectively funded at just 26.5%.
THE MAYOR’S WORDS
Lightfoot acknowledged that “hard choices” lay ahead on revenues and spending but she pledged the process would be done with “transparency, integrity and a determination to put our pensions on a true path to solvency” without doing it on the backs of the working class.
Predecessor Rahm Emanuel, who did not seek a third term, turned to a record $548 million property levy and other new and higher taxes and fees to increase pension funding under new payment schedules aimed at reaching a 90% funded ratio between 2055 and 2057.
The size of the next year’s gap remains clouded. Lightfoot late last week warned the number “is far bigger than this administration has disclosed to the public,” but in the interview broadcast on the Sun-Times’ “The Fran Spielman Show,” Lightfoot declined to go further.
Lightfoot has reiterated her reluctance to raise property taxes and said she hopes to have a discussion with labor on costs. She will also look to the state for help but just how the cash-strapped state could help is unclear. Lightfoot likely would push for local governments to get a bigger share from the additional revenue expected should the state eventually shift to a graduated income tax rate structure.
On pensions, Lightfoot said one measure she is looking at is some form of consolidation among the administrative functions of the city’s four funds.
Lightfoot remains opposed to the up to $10 billion pension obligation issue pitched by Emanuel last year.
"I think there are some structural problems with bringing that kind of product to market,” Lightfoot said in the Spielman interview. “I just don't know that's a viable option and it's risky” given the bankruptcies of several California cities and Detroit that followed POB issues. “I don't think we can bring that product to market and the risk I think is too great for us."
Lightfoot also dismissed the idea of taxing some retirement income that was recently pitched by Emanuel. Lightfoot opposes any cuts to current public employee pension benefits and opposes amending the constitution, as endorsed by Emanuel, to allow cuts.
Lightfoot rolled out a series of appointments following her first cabinet meeting, including the announcement that the heads of the city’s sister agencies will remain in their current positions, as well as the head of the police department.
Eddie Johnson remains Chicago Police Department superintendent; Janice Jackson remains chief executive officer of Chicago Public Schools; Juan Salgado remains chancellor of City Colleges of Chicago Chancellor; Dorval Carter remains president of the Chicago Transit Authority; Michael Kelly remains general superintendent of the Chicago Park District; and Eugene Jones remains CEO of the Chicago Housing Authority CEO.
Lightfoot announced the appointment of Emanuel budget director Samantha Fields as senior advisor for legislative counsel and government affairs and acting commissioners for the public health, planning and development and transportation departments during a search for permanent commissioners. Lightfoot had previously said she hoped to keep city Aviation Commissioner Jamie Rhee, who is managing the $9 billion expansion of O’Hare International Airport.
Lightfoot received on Friday reports from her 10 transition committees, but a special task force on finances has not yet reported back.
Key tests loom on Lightfoot’s ethics reforms and she risks alienating some council members.
“For years, they’ve said Chicago ain’t ready for reform,” Lightfoot said in her address, referencing the famous quote from corrupt political boss Paddy Bauler. “Well, get ready because reform is here.”
Lightfoot’s first official act was to sign an executive order instructing city departments to end the practice of deferring to aldermanic prerogative on permits and licensing in their wards. Lightfoot plans to tackle the bigger issue of local zoning powers through legislation in the future.
The next council meeting is set for May 29 and a first test of Lightfoot’s relationship with the council will come in a vote on her recommendations for committee chairs. She chose Alderman Scott Waguespack, head of the Progressive Caucus and frequent Emanuel critic, to serve as finance chairman, but is facing pushback from some members on that and other picks.
The market will also be watching for how Lightfoot balances the city’s fiscal strains with her pursuit of an agenda that includes expanding some services in areas like mental health and neighborhood investments while relaxing the city’s reliance on some revenue sources like red light cameras.