Chicago faces skeptics as it advances securitization plans

BY SourceMedia | MUNICIPAL | 10/10/17 07:04 PM EDT By Yvette Shields

CHICAGO – Chicago is close to gaining City Council sign-off on its new securitization bonds, making investors the next target of city officials pitching the program.

Council members are expected as soon as Wednesday to approve Mayor Rahm Emanuel’s ordinance establishing a special entity corporation. The measure authorizes the city to use the corporation to leverage sales tax revenues that flow from the state to refund general obligation and sales tax-backed debt.

The city's chief financial officer, Carole Brown, told aldermen -- some of whom expressed skepticism and want more time to assess the program's benefits-- that the new credit structure will lower debt service costs without adding to the city’s risk profile.

“It’s natural for us as legislators to be cautious, having been burned on a few deals in the past,” Alderman Brendan Reilly said during a three-hour Finance Committee debate last week.

The bankruptcy-remote legal provisions of the structure, removal of city operating risk, and statutory lien “should give us a better rating” and in turn “that should give us much lower rates,” Brown said. “I think it is a prudent thing for the city to do.”

The city will assign its sales tax revenue to the new corporation that will issue bonds backed by the revenue, insulating the bonds from potential future city distress. Similar structures used in New York, the District of Columbia, and Philadelphia have won high-grade ratings.

The authorization cleared the Finance Committee after Brown laid out the plan and tried to quell the misgivings of aldermen who believe the approval process has moved to quickly or worry that their oversight powers will be diminished.

Aldermen have been stung in the past for rubber stamping Emanuel's and former Mayor Richard Daley’s bond financings and Daley’s asset lease deals. That led to criticism as the public soured on the 2008 parking meter system lease and the city’s practice of using debt to for budget relief made headlines.

The promised savings tamp down the worry for many aldermen, especially as the city is trying to erase about $260 million of red ink in its next budget that will be unveiled Oct. 18.

“It may be an intricate plan that you have here, but others have used it. If it’s been beneficial … why would it not be beneficial for us?” said Alderman Carrie Austin, who chairs the council’s Budget Committee.

The bonds will be well received when the city brings the first tranche of borrowing in a $600 million to $700 million deal later this fall, said Brian Battle, director of trading at Performance Trust Capital Partners, although the precise savings is still unclear as the market will impose some penalty for both the Chicago and Illinois names.

It’s a new credit, so buyers constrained by their current holdings can participate in the deals, Battle said. The lockbox on revenues is also appealing, and Chicago's name will raise the yield over comparable credits.

“It’s an opportunity for buyers in the market to buy a really secure credit structure at a little cheaper price because of issuer,” Battle said. “The downside is for existing creditors to the city,” including GO holders and vendors, because they be moved behind the new securitization holders.


Several aldermen questioned the approval process and whether their future powers were being diluted. Brown repeatedly assured them that just like typical city bond deals they must sign off.

“I think this whole deal is not transparent enough,” said Alderman David Moore.

“We are not usurping in any way the oversight the council has,” Brown said. “The city council is not removed from the process.”

Aldermen Scott Waguespack and John Arena, members of the Progressive Caucus, said their questions over the long-term impact of the borrowing program and whether it opens the door to future borrowing abuses were not fully addressed and they voted against advancing the measure.

Both said additional hearings should be held and they would like independent fiscal advice. Both said Brown has been responsive in answering their questions but they are concerned over how future CFOs or a future administration might use the ordinance.

A delay that allows for more vetting and discussion “would give some of us more assurance” that they had “turned over every stone” and found nothing harmful, Arena said after the hearing.

Waguespack said he’s not fully convinced the new program, despite the promised savings, isn’t another form of scoop-and-toss debt restructuring which the Daley administration began doing a decade ago for budget relief and Emanuel continued. Emanuel is ending the practice as part of a series of debt practice reforms.

“You are making a short term gain for this budget and maybe a couple more budgets ahead, but what happens 20 or 30 years from now?” Waguespack said after the hearing.

The administration introduced the ordinance last month and Brown has held several briefings for aldermen. “We’ve made every attempt to try to educate the council before we brought” the ordinance, Brown said.

Brown said structuring details on maturities are still in the works so she can’t say with certainty that some existing debt won’t extend beyond its current maturity but she stressed that “our intent is to do refunding” for traditional debt service savings and not for “restructuring” purposes.

Future use adding to the city’s debt burden remains a worry for Arena and Waguespack.

Brown left the door open during the hearing to using the program to tap other revenue streams and possibly to raise new money. The state legislation included in the fiscal 2018 budget packages allows for home rule units to securitize revenue streams that flow through the state. They include sales taxes, motor fuel revenues, gambling, and other taxes.

“I’m not closing out the possibility,” Brown told aldermen, adding that other revenue streams would be “evaluated” to decide whether it was “prudent” to tap in the future. Brown also left open the door to consider using the entity to eventually raise new money at “a lower cost to taxpayers,” but made clear that was not her current recommendation.

Improved spreads seen after the city announced its intentions could reflect the market’s initial view that the new program will ease some pressure on the city’s GO credit and make it scarcer, Paul Mansour, head of municipal credit research at Conning, said in a recent interview.

But multiple market participants cautioned that the bankruptcy remote structure is not sure proof until truly tested. Greater interest in the use of securitization and dedicated revenue structures have grown out of Detroit and Puerto Rico’s bankruptcies, where structures once thought safe were challenged.

“In a potential bankruptcy situation, the inevitable question will once again arise: if more credits can get to the front of the line, then who gets left behind? The holders of the original full faith and credit GO bondholders of course,” NewOak’s Triet Nguyen, head of public finance credit, wrote in a recent edition of the firm’s MuniCredit Insights.

Nguyen said Fitch Ratings and S&P Global Ratings were asked at a recent Municipal Analysts Group of New York discussion if an issuer could face GO downgrades it continued to carve out revenues. The decision will be driven by the overall debt burden and debt capacity, the analysts said.

Brown sought to quell concerns. To existing GO bondholders, she offered the reminder that a portion of the sales tax is already tapped to back existing bonds and to pensioners who could see their position also diminished in a distressed situation she stressed that bankruptcy is not an option.

“The city doesn’t have the ability to file bankruptcy” under state law and it doesn’t have the “intention” to seek such approval, she said. The city has also put in place over the last year new funding streams to improve its weak pension system and she said the mayor would not “renege” on his commitment to the funds.

Brown has promoted the use of the program as a means to help rebuild the city’s battered ratings that range from a low of junk from Moody’s Investors Service to the triple-B category from the other three.

Brown told aldermen the program coupled with a show of “fiscal discipline” on pension funding, chipping away at the structural deficit, and shedding poor debt management practices, the city could improve its GO ratings in the coming years. She cited rating gains by New York, D.C., and Philadelphia.

Battle and Nguyen said that’s a big leap to make.

“Any future improvement in the city’s base GO rating will come from the overall debt burden being reduced, among other factors, not from this financial gimmick,” Nguyen said.

Other factors contributed to the other three cities’ upgrades.

“All three have been under some type of oversight that required fiscal discipline,” Battle said.

Brown said Thursday the city hoped to get into the market around late November but that’s market driven given the influx of Illinois paper looming with deals planned by the state, CPS, tollway, and others.

Bankers have told the city believes it can shave about 2% off its past GO borrowing costs with its spread coming in under 100 basis points to the Municipal Market Data’s top-rated benchmark. City spreads had topped 300 basis points on its last GO pricing but have narrowed since narrowed to just under 200 bp.

The city expects to tap the $3 billion authorization in about four deals over the next several years as it seeks to take out its sales tax bonds and higher coupon mostly callable GOs.

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