Chicago has tested the bond market for the first time since its bond rating dropped four notches — and passed more easily and at less cost than anticipated.
In fact, the demand for Chicago’s general obligation bonds was so robust and interest rates so unexpectedly favorable, Chief Financial Officer Lois Scott made what she called a “game-time decision” to sell $884 million in bonds all at once.
The original plan was to sell the bonds in two installments — half now to refinance so-called “short-term commercial paper” used to bankroll 2013 capital projects, when Chicago skipped the normal G.O. bond issue, the other half this fall to finance this year’s capital projects.
The City Council approved the borrowing last month, before Moody’s Investors dropped Chicago’s bond rating another notch citing “massive and growing unfunded pension liabilities” that “threaten the city’s fiscal solvency” without “major revenue” and budget cuts “in the near term” and for years to come.
The reduction — from A3 to Baa1 with a negative outlook — came eight months after Moody’s ordered an unprecedented, triple-drop in the bond rating that determines city borrowing costs.
Last fall — even before the second Moody’s downgrade — Scott warned aldermen that the unprecedented downgrade would cost taxpayers $1 million a year for every $100 million borrowed and severely limit the city’s “financial flexibility” going forward.
“It is much more expensive for us to keep the city operating financially, and it limits our accessibility. . . Our opportunities to maneuver have become much more restrictive,” Scott said then.
That turned out to be overly pessimistic. It ended up costing about one-third as much as Scott’s projection.
When the city went to market late Wednesday, demand was high, with five times as many buyers as there were tax-exempt bonds to sell and four times as many buyers as there were taxable bonds to sell, Scott said.
Even after the bond issue was doubled, there was still $100 million more demand than there were bonds to sell.
Chicago taxpayers ended up paying an interest rate roughly 1.6 percentage points higher for the tax-exempt portion of the $884 million bond issue than they would have paid if the city had a triple-A bond rating.
“In our last borrowing in 2012 [before Moody’s dropped the bond rating four notches], we were about 1.35 percentage points different…It ended up costing less than we projected. The market was evidencing that they have confidence in the economy and confidence in the financial direction” Chicago is going, Scott said in a telephone interview Thursday.
“They recognize we have financial challenges. But they weighed that against what they’re seeing with us getting our financial house in order.”
In 2015, the city is required by state law to make a $600 million contribution to stabilize police and fire pension funds that now have assets to cover just 30.5 percent and 25 percent of their respective liabilities.
Mayor Rahm Emanuel wants the Illinois General Assembly to put off the balloon payment until 2023. That would give the city time to negotiate a painful mix of employee concessions and increased revenues without raising property taxes so high that it triggers an exodus to the suburbs.
Although the Illinois General Assembly’s recent approval of pension reforms for state employees, suburban and Downstate teachers and workers at the Chicago Park District “suggest that reforms may soon be forthcoming for Chicago,” Moody’s anticipates they will fall far short of a total solution to the crisis.
Investors are more optimistic, Scott said.
“The legislature passed pension reform for park employees and the state plan. That was a signal the markets have been looking for. Momentum on pension reform gave investors some reason to be hopeful about the prospects for the pension reform in the city,” she said.
Scott said the “extraordinary amount of time” spent answering questions from “dozens” of investors obviously “paid dividends” for Chicago taxpayers.
“We didn’t see the spread go higher” between the interest rate paid and what the city would have paid if it had a triple-A bond rating, she said.
Civic Federation President Laurence Msall praised the city for “good market timing.” But he’s concerned about Scott’s plan to issue $451 million in taxable and $432 million in tax-exempt bonds.
“The total cost of this borrowing is likely to exceed $750 million because of the back-loaded structure and heavy use of taxable debt. They’re not going to pay any principle for 20 years on much of this offering, which is a very expensive financing tool that provides short-term budget relief but creates long-term financial challenges for the city,” Msall said.
“It’s still an extraordinary amount of borrowing with very little transparency as to what the taxpayers will get for this money.”
Scott countered that $481 million of the borrowing is “debt we already have” with some of the money used for legal settlements and judgements inherited by the Emanuel administration. Some of it is at a fixed interest rate. Some is variable, she said.
“Where we could, we saved money and took variable mortgages and made it fixed rate. He’s right. It does come at a higher cost. But, it takes away the risk that interest rates will rise,” Scott said.
