CHICAGO — Faced with rockier post-tax reform market conditions, Chicago put off the pricing of its sales tax securitization borrowing and will use the delay to consider tinkering with its structure.
The city and its finance team plans to continue discussions with market participants and will look at adding a taxable advance refunding component. Tax-exempt advance refundings were eliminated in the reform package signed by President Trump. The city could also shift coupons and calls to cater to current demand.
The sale by the city's Sales Tax Securitization Corporation would have resulted in present value savings but “we are dealing with a new environment,” Chicago’s chief financial officer, Carole Brown, said in an interview.
It was decided more time was needed to “digest what we are hearing” and to consider where market interest is strongest in a way that benefits the city’s overall refunding plans and goals of the program, Brown said.
The tax-exempt market had eagerly anticipated the issue — boosted to $898 million from $795 million — due to the spread penalties it would offer compared to other double-A and triple-A paper because of the city’s weak general obligation ratings.
The finance team led by Goldman Sachs had been preparing to price the bonds Wednesday, but the decision was made to delay the sale before an order period opened. Goldman caught the market by surprise in its distribution of a notice on the delay that read “this transaction is being moved to next week as the corporation continues to evaluate structuring alternatives.”
While the city saw “some strengthening” in the market Wednesday, the overall tone still bothered the finance team, Brown said. “We decided it was in our best interest to take a step back and evaluate the structure and make sure that we are presenting the right structure given the current market environment.”
While the city may go next week, Brown stressed there’s no rush to get the deal done, although at least $90 million of savings tied to the refunding of existing bonds using the new bankruptcy-remote securitization structure is needed to balance the city's 2018 books.
“The whole thought behind asking the City Council for the total authorization and putting together the teams was to give us the flexibility to bring the deals when we liked the market,” Brown said. The council authorization approved last fall allows for the refunding of up to $3 billion of debt.
Several market participants said their surprise about the deal's delay was driven by improvements in the market over the last week after a Treasury sell-off and fairly stable conditions on Wednesday. The surprise sparked speculation over whether a big investor on the long-end might have opted to hold back or if jitters over securitization structures were on the rise, but Brown’s comments on tinkering with the structuring also made sense to some.
“It’s reasonable for the city to be careful because they are depending on the revenue” for their budget, said Matt Fabian, partner at Municipal Market Analytics.
The city in December launched the credit with a $744 million sale that refunded existing sales tax bonds. The city intends to follow the $898 million issue with another $500 million later in the year although the sizing of both future deals is tentative.
The city had fortuitous timing in the December sale entering the market on a day when yields were falling. The city faces more market turmoil now amid a flatter yield curve and ratios between munis and Treasuries on the rise.
The December sale offered shorter tax-exempt maturities limited to 2030 and the new deal is heavily backloaded in 2043 and 2048 terms. The last sale offered tax-exempts and taxable paper while all of the new deal was to be tax-exempt.
“There’s always risk in waiting but we are going to try to manage that risk” by looking at the market on a day-to-day basis, Brown added.
The paper carries a AA rating from S&P Global Ratings and AAA ratings from Fitch Ratings and Kroll Bond Rating Agency. All assign a stable outlook. The city’s GOs are rated from a low of junk to a high of BBB-plus.
The city has promoted the legal case for the bankruptcy-remote structure. The city’s share of sales taxes that flow from the state -- $660 million in 2016 – goes directly from the state to the corporation. The state legislation, ordinance and bond documents all approved last year offer protections such as a statutory lien and non-impairment provisions on the pledged revenues.
Worries over the sturdiness of the structure in an actual distressed scenario took a backseat to the market’s thirst for paper on the December deal that offered $175 million of tax-exempt paper and $400 million of taxable securities. It was five times oversubscribed with more than 70 traditional and non-traditional municipal investors, allowing the city to pare down initial yields.
The 10-year tax-exempt bond landed at a 23 basis point spread to the Municipal Market Data’s AAA benchmark and five bps over the AA. That compares to the secondary trading level of 170 bps on the city’s GOs.
The yield on the 10-year benchmark muni Wednesday was steady from 2.10% on Tuesday, while the 30-year GO yield was flat from 2.69%. U.S. Treasuries were weaker in late activity with the yield on the two-year rising to 2.05% on Wednesday from 2.01% on Tuesday, the 10-year Treasury yield gained to 2.58% from 2.55% and the yield on the 30-year Treasury increased to 2.85% from 2.84%.
On Wednesday, the 10-year muni-to-Treasury ratio was calculated at 78.0% compared with 82.6% on Tuesday, while the 30-year muni-to-Treasury ratio stood at 92.6% versus 94.9%, according to Municipal Market Data.