The Chicago skyline in August. Chicago is preparing to go to market with a refinancing deal that can help balance its budget.
Bloomberg News
A posh refinancing deal pricing next week continues Chicago’s move from scoop-and-toss practices but still front-loads savings to assist balance town’s budget.
The town 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 $1.5 billion refinancing measure in October.
The bonds are expected to cost via negotiated sale the week of Dec. 2.
The proceeds of the sales tax securitization bonds — together with the proceeds of the Series 2024B GO refunding bonds — will refund certain outstanding GO bonds and redeem the rest of those outstanding bonds via a young offer, which town made on Monday, and on which RBC Capital Markets is dealer-manager.
The combined package is anticipated to deliver front-loaded savings of around $70 million to $90 million to assist balance town’s fiscal 2024 budget, in line with S&P Global Rankings. A smaller amount of savings might be realized in 2025.
Chicago’s Chief Financial Officer Jill Jaworski said the 2024 budget included $89.2 million in projected savings from bond refundings, $19.2 million of which was realized from an earlier transaction.
“The choice to allocate a considerable portion of savings from this current transaction to budget 12 months 2024 is consistent with the budget plan passed by City Council last 12 months,” she said.
“You may call it what you wish, however it is a near-term, one-time savings solution,” said Lisa Washburn, managing director at Municipal Market Analytics. “To the extent that they depend on one-time solutions, it just makes addressing the present and future budget deficits harder.”
Because the 2025 budget debate continues to unfold, Washburn stressed town’s advance pension payment policy stays essential. It’s “unlucky that they are called supplemental payments,” when in actual fact they “serve to stem the expansion of the unfunded liability because contributions and investment returns haven’t been sufficient,” she said.
“When you have to balance the budget, and also you take a look at the bills which can be coming due within the out years as well, hard decisions are going to need to be made,” she added. “They are going to need to take a tough take a look at where the cuts are coming from and whether that is in the general best interests of town.”
The town faces each an acute money problem and a long-term structural budgetary problem, said Brian Battle, managing director at Performance Trust Firms. The administration of Mayor Brandon Johnson has managed to resolve the acute problem with this refinancing, but “by doing that, they will cause more stress within the out years,” he said.
“What hasn’t been addressed, and what is going on to present investors pause, is commentary around what are you going to do concerning the structural budget problem,” Battle said. “They’re in a extremely 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’s the mayor, he’s got to determine the way to fix it.”
An answer “will take years,” Battle said. “But town has to take affirmative motion to prove that it’s wrestling with the issue.”
Chicago stays vibrant and isn’t fighting a depopulation crisis or a business exodus. Battle said he’d take Chicago’s budgeting problems over the issues facing other Midwestern cities.
But town should release a three-year or five-year plan to repair its structural budgetary problems, he said. “That is what I believe everyone desires to see.”
Federal pandemic relief funds bailed town out lately, papering over its structural problems, and people funds are actually running out.
“Unfortunately for Chicago, the cash isn’t going to come back from the county and it is not going to come back from the state of Illinois, which has its own budget problems,” Battle added. “The rating agencies have been incredibly generous and patient with town. [But] I think town goes to get downgraded.”
Because the Johnson administration negotiates with the City Council on the 2025 budget, Jaworski said she hopes alderpeople will look to the administration’s 2025 budget recommendations, which include a continuation of town’s advance pension funding policy and other key goals.
“Elected officials should take into consideration the very real possibility of a rankings downgrade should town not meet the statutory deadline for passing a budget, or passing without key policies in place which have helped town course correct and begin meeting its pension obligations, in addition to managing its debt responsibly,” she said.
Ideally, Jaworski said, the administration would look to closing the sales tax loophole on services as “a structural solution to budget issues the state and city are facing.”
Within the meantime, she said, she and the remaining of Johnson’s team are “working diligently with aldermen to search out consensus on multiple measures that increase efficiencies and lift revenue. These negotiations are ongoing.”
The senior lien sales tax securitization bonds are rated AAA with a stable outlook by Fitch Rankings, AAA with a stable outlook by Kroll Bond Rating Agency (which placed Chicago’s GOs on Watch Downgrade earlier this month) and AA-minus by S&P, which placed Chicago on CreditWatch negative last week.
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, in line with an investor presentation. Co-financial advisors are Phoenix Capital Partners and PFM Financial Advisors. Co-transaction counsel are Miller, Canfield, Paddock and Stone and Zuber Lawler.
RBC serves as senior manager on the GO refunding Series 2024B bonds, in line with an investor presentation, and co-municipal advisors are Phoenix Capital Partners and PFM. Co-bond counsel are Chapman and Cutler and Charity & Associates.
The preliminary offering circular for the sales tax securitization bonds states the senior lien Series 2024A bonds are limited obligations of the Sales Tax Securitization Corp., payable solely from the sales tax revenues and other collateral pledged under the senior lien indenture.
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.
In response to the preliminary official statement, the GO refunding Series 2024B bonds are backed by town’s full faith and credit, with principal and interest payable from any funds of town legally available for such purpose.
“I do not know that they might be structuring the deal this fashion if not for the massive budget gap,” said Michael Rinaldi, senior director at Fitch. “It’s one other step that signals that their fiscal pressure is somewhat amped up in comparison with a few years ago.
“The opposite necessary piece for us is about whether the transaction extends the lifetime of the debt,” he added. “And on this case, I believe there was a really marginal increase in the typical lifetime of the refunding bonds versus the refunded bonds, so we took an in depth take a look at that, however it wasn’t material enough for us.”
Rinaldi said while Fitch has affirmed its rankings for now, it is not taking future rating motion off the table
“I believe the following few weeks might be necessary,” he said. “Things have modified dramatically from when the budget was initially proposed. … We did note that there is a higher level of discord in comparison with prior budgets.”
Fitch has taken positive motion on town over the past few years, driven partly by town’s ability to enhance its pension funding practices. The advance pension funding policy was a key a part of that, Rinaldi said.
The statutory contributions alone fall in need of actuarial recommendations and “put town able where every year, they’re not having sufficient funds available to proceed to make the present 12 months’s pension advantages without liquidating assets held within the respective pension plans,” Rinaldi said. The town projects significant savings over the following decade-plus in the event that they stay on this path, “which I believe is vital to its overall credit quality,” he said.
Scott Nees, director and lead analyst at S&P, said the professional forma schedule showed a bit of savings on the refinancing every year.
“It’s tilted toward the front end,” he said. “The important thing concern on our end is not that they are adding to leverage or extending maturities or anything like that; it’s more that they are having to resort to those one-time measures to balance the budget.”
“They don’t seem to be pushing the maturities out,” agreed Jane Ridley, S&P managing director and sector lead. “That is type of where we might draw the road.”
Nees noted Chicago’s tax-supported debt carrying costs remain fairly level at around 10% of governmental fund revenues and are “just about in keeping with what we see in other major cities.” The most important issue is pensions, he said.
Linda Vanderperre, senior director in KBRA’s public finance rankings group, also stressed that this refinancing doesn’t extend debt service.
“Of concern to KBRA is the undeniable fact that prospective refunding savings are critical to achieving budget balance in the present budget 12 months,” she said. “Along with refunding savings, FY2024 gap closure is reliant on other one-time actions, including the usage of [tax increment financing] surplus and prior 12 months fund balance.”
Vanderperre noted the present problems stem partly from the undeniable fact that prior to 2015, town had no input into pension contribution levels, which were set by the state and never based on actuarial recommendations, and which didn’t adjust for changes in investment returns or profit enhancements. The downturn in 2000 and the financial crisis also impacted town’s funded ratios.
The Lightfoot administration made significant progress on the pensions front, Vanderperre said, but in July, KBRA revised the outlook on town’s GOs to stable from positive, citing sizable outyear gaps and failure to make more progress toward structural balance.
Going forward, KBRA might be continued reliance on temporary gap-closing measures; progress toward actuarial pension funding, preferably through recurring revenue streams; and town’s commitment to replenishing the fund balance and maintaining long-term reserves.
The massive outyear structural imbalance is something S&P might be watching, Nees said.
“That imbalance in 2026 and 2027 may be very large, and is increasingly large, and that is under a base case scenario through which the economy is fairly stable,” he said. “And should you saw a downside scenario, you’d see a fair larger budget gap going forward. We have talked about how principally our BBB-plus rating is untenable within the face of such a big budget gap, within the absence of a transparent plan for addressing it.
“And so we do think that those budget gaps, to the extent that they are going to be that enormous, are a possible source of credit pressure if town doesn’t take motion sooner to begin chipping away at that,” he said.