Market awaits Chicago mayor-elect's first moves

BY SourceMedia | MUNICIPAL | 04/03/19 12:29 PM EDT By Yvette Shields

Lori Lightfoot made her case to Chicago's voters. She remains largely an unknown to the municipal bond market.

Lightfoot — a political novice who has yet to outline plans to manage Chicago's sea of red ink — easily claimed Tuesday's mayoral runoff against Toni Preckwinkle, the Cook County board president, winning the race to succeed Mayor Rahm Emanuel.

“The first thing Lori Lightfoot should be doing is reading the resumes of people with budget and public finance experience so she can put together an expert financial team,” given that she’s a fiscal unknown, said Brian Battle, director of trading at Chicago-based Performance Trust Capital Partners.

Matt Fabian, partner at Municipal Market Analytics, said while market players will watch to see if Lightfoot shows fiscal discipline by not unwinding gains made under Emanuel, they will also be curious to see “what she says about bonds and taxes” and how she will use debt and manage investor relationships.

It’s a positive, Fabian added, that she hasn’t said anything negative about bondholders as former Illinois Gov. Bruce Rauner did during his tenure.

Lightfoot was the top vote-getter among 14 in the non-partisan February race. Emanuel did not seek re-election. On Tuesday, she overwhelmingly beat Preckwinkle with 74% of the vote in a historic election that saw two African American women vying for the job. Lightfoot will also become the city’s first openly gay mayor.

When Lightfoot takes office May 20, she must find money to cover a scheduled $280 million pension payment increase and an estimated $250 million 2020 budget gap. She inherits one junk-bond rating and another only one notch away. The city runs on a $10.7 billion budget this year.

“If action is not timely or the city backslides on its progress toward structural alignment on full actuarial pension funding, S&P Global Ratings could take a negative rating action” on its BBB-plus rating, analyst Carol Spain warned in a recent report. Fitch rates Chicago BBB-minus, Kroll Bond Rating Agency assigns its A rating, and Moody's (MCO) applies the junk rating at Ba1.

Lightfoot has offered a range of ideas but lacks a plan — at least one that she has shared publicly — to address the fiscal reckoning.

The new mayor will also need to negotiate contracts with public safety unions and teachers and, while violent crime is down from the levels that grabbed national headlines in recent years, the summer season when shootings spike looms.

Another $310 million pension funding spike looms in 2022 and the city faces tax fatigue from hikes imposed by Emanuel to deal with pensions.

Lightfoot must also guard against deepening population losses, something she acknowledged in her victory speech.

“To thrive, Chicago must grow and if we make our streets safer, our schools better, our neighborhoods stronger, our businesses large and small more prosperous then people will want to stay and they will want to move here,” she said.

Expect bankers and advisors to descend on Lightfoot’s camp, banking sources said.

Some might offer one-shots or financing techniques that rating analysts warn against, and S&P cautioned against any back-peddling on Emanuel’s current pension funding schedule that ties payments to a 90% funded goal by 2058 for all four city funds.

A pitch to use pension obligation bonds is expected, said banking sources. Lightfoot opposed Emanuel’s proposed $10 billion taxable POB deal that supporters say would raise its pension funding ratio to more than 50% from 26.5%.

Lightfoot raised concerns about the inherent gamble that investment earnings would exceed bond interest. She also said the bankruptcies of cities like Detroit that used pension bonds offered a cautionary tale.

"There's been no transparency” about the deal structure and “we need to know about what the income stream is for that $10 billion,” she said in interviews.

At the same time, Lightfoot has not adamantly ruled out a POB and bankers say the pitch will be to refashion the mayor’s plan as part of a package that could include revenues and other changes to make it more palatable to the city council and bond market.

Any POB would face skeptics. “It could provide near-term budget relief but at the expense of potentially greater long-term expenses because investment returns could likely fall short of debt service,” S&P wrote.

“Overnight that would dramatically increase the city’s debt leverage and there’s also execution risk,” Fabian said.

Asset transfers or a lease of Midway Airport could be pitched but the city has few assets that could make a material impact and a bitter taste remains over problems with the city’s 2008 parking meter lease.

First up is the selection of a transition team. The city’s chief financial officer, Carole Brown, is ready to move on and there is no public pool of candidates to replace her.

Bankers will also be watching for her selection of the next City Council finance chairperson. The longtime chairman, Alderman Ed Burke, stepped down late last year after he was charged by federal authorities with shaking down a local business owner. Speculation is that Progressive Caucus chair Alderman Scott Waguespack is a front-runner.

The market is also watching for how Lightfoot will balance fiscal restraint with her progressive promises on neighborhood investment and governance reforms.

Investors viewed Emanuel favorably for raising taxes for pensions and ending scoop-and-toss debt restructuring. They rewarded those gains by cutting in half spreads on the city’s general obligation sale last week compared to its last sale in 2017.

Lightfoot treaded cautiously in her campaign trail comments about taxes.

“People in the city feel like they are nickel-and-dimed to death and before we talk about revenue and I favor progressive forms of revenue we have to make the case for more revenue" by showing we are “proper fiscal stewards,” Lightfoot said.

Lightfoot said reforms include installing a risk manager to better manage judgments and settlements that cost the city $113 million last year. She wants to reform the city’s workers' compensation program and will look at consolidation of city posts.

Lightfoot supports a new invoice tax on large accounting and legal firms to fund pensions, raising the city’s real estate transfer tax in a graduated fashion to fund affordable housing, and raising the hotel tax to provide artist grants. She supports raising ride-hailing fees.

The mayor-elect has said she opposes raising the sales tax, resurrecting a business head tax, imposing a commuter tax, taxing on financial transactions or imposing a city income tax. She also opposes a property tax hike, for now. She says the new county assessor must first reform the system and she first needs to comb through the budget for savings.

Lightfoot opposes any cuts to current public employee pension benefits and opposes amending the constitution, as endorsed by Emanuel, to allow cuts. She supports implementing some form of a new tier of benefits for new employees but not a shift to a defined-benefit 401(k)-style retirement program.

At the state level, she will find a friendly ear in Gov. J.B. Pritzker, but the state has its own deep fiscal ills. Lightfoot supports Pritzker’s efforts to amend the constitution to allow a shift to a graduated income tax from a flat tax, which could generate more shared revenue for the city.

She supports state approval for a Chicago-owned casino and Pritzker’s proposal to legalize recreational cannabis while more study is needed on whether the city should legalize video gambling.

Lightfoot advocated during the campaign shifting Chicago Public Schools to an elected school board. It's now appointed by the mayor.

She supports city funding to replace lead water pipes but that would carry a costly tab.

Lightfoot is a native of Massillon, Ohio. She graduated from the University of Michigan and later moved to Chicago to attend the University of Chicago law school. She most recently was a senior equity partner in the litigation practice at Mayer Brown LLP, which does bond and other business with Chicago. She is close to her mentor at Mayer Brown, partner Tyrone Fahner, who has served as the firm’s chairman and is a former Illinois attorney general.

Lightfoot lives on the near Northwest Side neighborhood of Logan Square with her wife and daughter and is a Bears season-ticket holder.

She has been an assistant U.S. attorney in the criminal division and held a series of jobs and appointed positions with the city, including chair of the Police Accountability Task Force, president of the Chicago Police Board, first deputy of procurement services, and general counsel of the Chicago Office of Emergency Management and Communications.

Jane Byrne was Chicago's first female mayor; she was elected in 1979 and served one term. Harold Washington was the first African American mayor. He died in office shortly after his re-election in 1987.

In general the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so avoiding losses caused by price volatility by holding them until maturity is not possible.

Lower-quality debt securities generally offer higher yields, but also involve greater risk of default or price changes due to potential changes in the credit quality of the issuer. Any fixed income security sold or redeemed prior to maturity may be subject to loss.

Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.