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Chicago pulls off $674 million refinancing, but at a heavy price tied to junk status

Cash-strapped Chicago eased its immediate financial crisis Wednesday by converting $674 million of variable rate debt to fixed interest rates, but paid a heavy price tied to its junk bond rating.

Mayor Rahm Emanuel’s administration was quick to declare victory, claiming demand for the bonds — with $6 billion in orders for $674 million in general obligation debt — “shows that investors remain confident in the city’s credit and a secure economic future for Chicago.”

But the Illinois Supreme Court ruling overturning state pension reforms that put Emanuel’s city reforms in similar jeopardy and triggering a double-downgrade by Moody’s Investors Service was costly for Chicago taxpayers.

On the 27-year bonds, the city was forced to pay an interest rate of roughly 5.84 percent. A city with a AAA-bond rating would likely have paid about 2.5 percentage points less.

City Hall also disclosed Wednesday that it intends to refinance an additional $132 million of variable debt by using its existing short-term line of credit. The interest rate on that short-term borrowing has not yet been disclosed.

“The city was able to achieve those aggressive interest rates due to overwhelming demand for its bonds and investors assessing the ability of Mayor Emanuel and his finance team to adapt and manage through the effects of the Moody’s downgrade,” the mayor’s office said in a statement.

Matt Fabian, a partner at Massachusetts-based Municipal Market Analytics, estimated the double-downgrade by Moody’s forced Chicago to pay “anywhere from one-half-of-one percent to one full percentage point” more than it would have paid before the downgrade.

The penalty was somewhat minimized by the fact that “investors had already been pushing back on Chicago borrowings and demanding higher yields” amid concern about the combined $30 billion pension crisis at the city and public schools, he said.

But Fabian said what’s more important for Chicago is that it pulled off a refinancing that will keep the wolf away from the city’s door.

When its bond rating from Moody’s fell below investment grade and into junk-bond status, Chicago could have faced paying nearly $2.2 billion to bankers under a series of complex deals dating back to former Mayor Richard M. Daley’s tenure.

“It was critical that the city get this bond deal done and avert what could have been a very difficult cash crisis,” Fabian said. “If the banks had demanded their money, it likely would have gone to court. It wouldn’t have been pretty. And no matter what the resolution was, it would have been worse than the price the city is paying for the restructuring.

“Just like your mortgage, the city can refinance these bonds at some point to reduce the interest rate,” he added. “But it was more important that the city demonstrate it has access to the markets and could restructure these short-term notes.”

Fabian said the “undeniably high” interest rate should “send a message” loud and clear to Emanuel and the new City Council: Get going on a local solution to the combined, $30 billion pension crisis at the city and public schools. Don’t wait for the Illinois General Assembly that appears headed into overtime to go first.

“The interest rate they’re paying is affordable, but that doesn’t mean it doesn’t sting. There’s a rhetorical message here telling the city not to be complacent and reform its finances in the near term. Chicago may be the third-largest city. It may have options. But the market is treating Chicago as if it is a junk bond. If the city wants better treatment, it needs to fix its finances and fix its liabilities,” Fabian said.

Emanuel said last week he wanted to wait and see how the frenzied final days of the spring session play out before asking the new City Council to begin the search for new revenue to solve the pension crisis.

But, Fabian said, “It’s hard to expect much good is gonna come out of Springfield for the city. It seems a bit of a pipe-dream. I’ve heard the governor is even stalling on the casino bill. The city would be better served by taking matters into its own hands. There is a risk in waiting too long.”

Market analyst Brian Battle agreed that Chicago had no choice but to refinance. He argued that investors appeared to be driven largely by the discount that the bonds were sold at, meaning the long-term costs to the city could be considerable.

The reception from the markets was great, but that was “because the bonds are so cheap,” said Battle, who is director of trading for Performance Trust Capital Partners, a Chicago firm that analyzes bonds for investors.

The city’s low credit rating meant the interest rate on Wednesday’s deal was much higher than for a government selling better-rated bonds. Deals like Chicago’s are only available in Puerto Rico, which has serious fiscal problems, Battle said.

He estimated the higher rates would end up costing the city hundreds of millions of dollars over the life of the deals.

“That would be conservative,” Battle said. “It’s the cost of being downgraded.”

Emanuel’s long Springfield wish list could be held up by the power struggle between House Speaker Michael Madigan (D-Chicago) and rookie Republican Gov. Bruce Rauner.

The mayor wants a publicly owned Chicago casino with all of the revenue used to shore up police and fire pensions. He wants to resurrect his 2011 proposal to broaden the sales tax to an array of services not now covered.

And he needs the Legislature to lift the hammer hanging over Chicago taxpayers — a state-mandated, $550 million payment due in December to shore up police and fire pensions — to give taxpayers more time to “ramp up” to that balloon payment.

Emanuel needs similar relief for the teachers pension fund by ending what he calls the “dual taxation” that forces Chicagoans to pay for the retirement of city teachers and for teachers outside Chicago.

Yet another bill has surfaced in Springfield that would extend for two more years the 56 percent increase in Chicago’s telephone tax used to stave off a pre-election property tax hike to cover the city’s increased contribution to the Municipal Employees and Laborers pension funds.

Civic Federation President Laurence Msall said he can’t calculate the total cost to Chicago taxpayers “until prices for all of the maturities have been sold and become available” and until the deal is closed on June 1.

But, he said, “it is clear that the city has taken a necessary and important step in refinancing its debt that will also be very expensive compared to other more stable and higher- rated local governments.”

Chicago Public Schools, which also was downgraded to junk status last month, undertook a $300 million bond sale last month. Like the city, CPS found plenty of buyers but the school district paid a relatively high interest rate that will mean greater costs for taxpayers over the life of the deal.