Exclusive: A financial time bomb in Chicago

Written By Dan Mihalopoulos Posted: 06/18/2014, 09:27am

Already facing a host of financial worries, Mayor Rahm Emanuel’s administration could be stuck with a nearly $200 million tab as a result of betting heavily on risky interest-rate “swaps” under former Mayor Richard M. Daley.

The deals required the city to maintain a certain credit rating, but the rating has fallen since the Daley administration made them, putting the city at risk. 

The financial institutions involved could terminate the deals and demand immediate payment if the ratings agency Moody’s Investor Service drops the city’s credit rating again — which it has warned it will do unless Chicago’s underfunded pensions are dramatically reformed.

Taxpayers could end up owing bankers and other financial institutions, including Wells Fargo and Loop Capital Markets, $110.4 million if Moody’s drops its rating for Chicago by one notch, according to documents reviewed by the Chicago Sun-Times. Falling two more levels could cost the city another $88.5 million.



Moody’s dropped the city’s bond rating three notches last July. Then it lowered the rating again in March by another notch to the current Baa1 status.

Most of the swap agreements — which date as far back as 1999 — peg the termination threshold to any drop below Baa1.

In announcing the latest drop, Moody’s said its outlook for Chicago was “negative,” warning that only new revenues and reduced costs could avert further ratings declines.

Another ratings drop would present the city of Chicago with the kind of problem Detroit experienced before it fell into bankruptcy. In 2012, Detroit’s bond rating went below the level it needed to maintain under its swap deals, giving bankers the right to claim about $350 million from the Michigan city. The bankruptcy judge in Detroit’s case recently whittled what he said the city would have to pay the bankers to $85 million, after rejecting two larger settlement figures that city officials and bankers there had agreed on.

With the ability to borrow and reserves of more than $600 million, Chicago is in a much better position to come up with the money than Detroit was. But the sudden termination of the swaps would add another big-ticket item to a long list of bills that the city hasn’t yet found a way to pay. 

Emanuel aides say they are trying to lessen the city’s potential exposure in the event the swaps are terminated because of a ratings drop.

City officials have negotiated recently with bankers involved in the swaps to lower the threshold for triggering the termination of three of the deals, with Morgan Stanley, Goldman Sachs and Bank of New York Mellon.

Those moves could save the city tens of millions of dollars or, at least, postpone the day of reckoning.

“We’re working to reduce the amount that we have at stake,” said Steve Koch, Emanuel’s deputy mayor.

Still, under 14 of the 21 swaps the city is involved in, the financial institutions have the right to demand payment after a downgrade of even one notch by the bond-rating agency, records show. 

If the city’s rating falls below the current level, the administration could be forced to pay the biggest sums to Wells Fargo and to a subsidiary of Chicago-based Loop Capital Markets, led by Jim Reynolds, an Emanuel appointee to the Illinois Sports Facilities Authority and World Business Chicago. As of Feb. 28 — the most recent available figures, according to city officials — Wells Fargo would be able to demand nearly $40.9 million and Loop Capital Markets could claim more than $34.3 million, records show. 

A spokesman for Wells Fargo declined to comment. Reynolds did not return calls.

Chicago has more than $8.3 billion in outstanding bond debt — money it borrowed by selling bonds. 

To protect against fluctuating interest rates, the city entered into swap agreements affecting about $3 billion of its debt, records show. Had interest rates risen since those deals were signed, the city would have saved money. Instead, rates have dropped.

Koch and other top Emanuel aides said the city hasn’t entered into any new swap agreements since Emanuel succeeded Daley in 2011 and would not be doing so.

“All of these were done before the current administration,” Koch said. “I’m not here to argue with whether that was good, bad or indifferent. What I can tell you is we don’t do it, and we basically stopped doing it when the mayor took office.”

A spokeswoman for Daley declined to comment.

Laurence Msall, president of the Civic Federation, said the swaps were “entered into at a time when it seemed unlikely” the city’s bond rating could fall as far as it has.

If the rating falls again, Msall said, “The most reasonable expectations would be that the banks would be looking to secure their financial interest.”

Under Daley, the city also entered into a series of swaps involving water, sewer and Midway Airport bonds. On Feb. 28, the city was about $175 million in the red on those deals, records show. The water, sewer and Midway swaps have termination clauses similar to the other deals. 

But even though the ratings for water and sewer bonds have been downgraded, they remain above the threshold for terminating the swaps.

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