Chicago’s refinancing steers clear of scoop-and-toss
7 min read
Bloomberg News
A complex refinancing deal pricing next week continues Chicago’s move from scoop-and-toss practices but still front-loads savings to help balance the city’s budget.
The city will issue $142.09 million of sales tax securitization bonds, refunding Series 2024A; $404.22 million of second lien sales tax securitization bonds, refunding Series 2024A; $133.37 million of second lien sales tax securitization bonds, taxable refunding Series 2024B; and $126.595 million of general obligation bonds, refunding Series 2024B after the City Council passed a
The bonds are expected to price via negotiated sale the week of Dec. 2.
The proceeds of the sales tax securitization bonds — along with the proceeds of the Series 2024B GO refunding bonds — will refund certain outstanding GO bonds and redeem the remainder of those outstanding bonds via a tender offer, which the city made on Monday, and on which RBC Capital Markets is dealer-manager.
The combined package is expected to deliver front-loaded savings of around $70 million to $90 million to help balance the city’s fiscal 2024 budget, according to S&P Global Ratings. A smaller amount of savings will be realized in 2025.
“You can call it what you want, but it is a near-term, one-time savings solution,” said Lisa Washburn, managing director at Municipal Market Analytics. “To the extent that they rely on one-time solutions, it just makes addressing the current and future budget deficits harder.”
As the
“When you need to balance the budget, and you look at the bills that are coming due in the out years as well, hard decisions are going to have to be made,” she added. “They’re going to have to take a hard look at where the cuts are coming from and whether that’s in the overall best interests of the city.”
The city faces both an acute cash problem and a long-term structural budgetary problem, said Brian Battle, managing director at Performance Trust Companies. The administration of Mayor Brandon Johnson has managed to solve the acute problem with this refinancing, but “by doing that, they are going to cause more stress in the out years,” he said.
“What hasn’t been addressed, and what’s going to give investors pause, is commentary around what are you going to do about the structural budget problem,” Battle said. “They’re in a really tough spot.”
Johnson, he said, “inherited a long-term structural budget problem that has come into sharp focus during his administration.” And while he noted the mayor didn’t create this problem, “since he is the mayor, he’s got to figure out how to fix it.”
A solution “will take years,” Battle said. “But the city has to take affirmative action to prove that it’s wrestling with the problem.”
Chicago remains vibrant and is not struggling with a depopulation crisis or a business exodus. Battle said he’d take Chicago’s budgeting problems over the problems facing other Midwestern cities.
But the city should release a three-year or five-year plan to fix its structural budgetary problems, he said. “That’s what I think everyone wants to see.”
Federal pandemic relief funds bailed the city out in recent years, papering over its structural problems, and those funds are now running out.
“Unfortunately for Chicago, the money is not going to come from the county and it’s not going to come from the state of Illinois, which has its own budget problems,” Battle added. “The rating agencies have been incredibly generous and patient with the city. [But] I suspect the city is going to get downgraded.”
The senior lien sales tax securitization bonds are rated AAA with a stable outlook by Fitch Ratings, AAA with a stable outlook by Kroll Bond Rating Agency (which
The second lien Series 2024 bonds are rated AA-minus by Fitch and S&P and AA-plus by KBRA.
The GO refunding Series 2024B bonds are rated A-minus with a stable outlook by Fitch, A (Watch Downgrade) by KBRA and BBB-plus (CreditWatch negative) by S&P.
RBC Capital Markets is senior manager on the STSC bonds, according to
RBC serves as senior manager on the GO refunding Series 2024B bonds, according to
The
The second lien bonds are payable from sales tax revenues and other collateral pledged under the second lien indenture and are secured on a parity basis with other second lien bonds.
The Sales Tax Securitization Corp. was created in 2017 as a special purpose, bankruptcy-remote not-for-profit organization.
According to the
“I don’t know that they would be structuring the deal this way if not for the large budget gap,” said Michael Rinaldi, senior director at Fitch. “It is another step that signals that their fiscal pressure is somewhat amped up compared to a couple of years ago.
“The other important piece for us is about whether the transaction extends the life of the debt,” he added. “And in this case, I think there was a very marginal increase in the average life of the refunding bonds versus the refunded bonds, so we took a close look at that, but it wasn’t material enough for us.”
Rinaldi said while Fitch has affirmed its ratings for now, it’s not taking future rating action off the table
“I think the next few weeks will be important,” he said. “Things have changed dramatically from when the budget was initially proposed. … We did note that there’s a higher level of discord compared to prior budgets.”
Fitch has taken positive action on the city over the past few years, driven in part by the city’s ability to improve its pension funding practices. The advance pension funding policy was a key part of that, Rinaldi said.
The statutory contributions alone fall short of actuarial recommendations and “put the city in a position where each year, they’re looking at not having sufficient funds available to continue to make the current year’s pension benefits without liquidating assets held in the respective pension plans,” Rinaldi said. The city projects significant savings over the next decade-plus if they stay on this path, “which I think is important to its overall credit quality,” he said.
Scott Nees, director and lead analyst at S&P, said the pro forma schedule showed a little savings on the refinancing each year.
“It is tilted toward the front end,” he said. “The key concern on our end isn’t that they’re adding to leverage or extending maturities or anything like that; it’s more that they’re having to resort to these one-time measures to balance the budget.”
“They’re not pushing the maturities out,” agreed Jane Ridley, S&P managing director and sector lead. “That’s kind of where we would draw the line.”
Nees noted Chicago’s tax-supported debt carrying costs remain fairly level at around 10% of governmental fund revenues and are “pretty much in line with what we see in other major cities.” The main issue is pensions, he said.
Linda Vanderperre, senior director in KBRA’s public finance ratings group, also stressed that this refinancing does not extend debt service.
“Of concern to KBRA is the fact that prospective refunding savings are critical to achieving budget balance in the current budget year,” she said. “In addition to refunding savings, FY2024 gap closure is reliant on other one-time actions, including the use of [tax increment financing] surplus and prior year fund balance.”
Vanderperre noted the current problems stem partly from the fact that prior to 2015, the city had no input into pension contribution levels, which were set by the state and not based on actuarial recommendations, and which failed to adjust for changes in investment returns or benefit enhancements. The downturn in 2000 and the financial crisis also impacted the city’s funded ratios.
The Lightfoot administration made significant progress on the pensions front, Vanderperre said, but in July, KBRA revised the outlook on the city’s GOs to stable from positive, citing sizable outyear gaps and failure to make more progress toward structural balance.
Going forward, KBRA will be looking at continued reliance on temporary gap-closing measures; progress toward actuarial pension funding, preferably through recurring revenue streams; and the city’s commitment to replenishing the fund balance and maintaining long-term reserves.
The large outyear structural imbalance is something S&P will be watching, Nees said.
“That imbalance in 2026 and 2027 is very large, and is increasingly large, and that’s under a base case scenario in which the economy is fairly stable,” he said. “And if you saw a downside scenario, you’d see an even larger budget gap going forward. We’ve talked about how basically our BBB-plus rating is untenable in the face of such a large budget gap, in the absence of a clear plan for addressing it.
“And so we do think that those budget gaps, to the extent that they’re going to be that large, are a potential source of credit pressure if the city doesn’t take action sooner to start chipping away at that,” he said.
