In a measure of how serious Chicago’s financial woes have become, the city will pay unusually high interest rates on a $674 million borrowing deal reached Wednesday — the first since a major debt rating agency lowered Chicago’s creditworthiness to junk status this month.
A Tribune analysis estimated Chicago is paying at least $70 million more to borrow the money than if the city were rated at the higher level it was just 15 months ago.
Mayor Rahm Emanuel had little choice about whether to go through with the deal. Banks had given the city until June 8 to pay back $800 million in outstanding debt — deals whose terms specify a junk rating as a deal breaker. Emanuel is using the new fixed-rate bonds to pay off much of that debt and alleviate fears that the city could run low on cash.
“Today we successfully executed one part of that strategy that will eliminate a substantial amount of taxpayer risk,” the city’s new chief financial officer, Carole Brown, said in a statement.
Investors flocked to buy the high-interest bonds — which Brown said shows they “remain confident in the city’s credit and a secure economic future for Chicago.”
Chicago finance officials had originally considered doing this deal May 19 but decided to delay the deal rather than price bonds barely a week after the junk status downgrade from Moody’s Investors Service. Still, Chicago is paying bond rates unheard of for most governments — at a time when the city can least afford it. The city is already devoting nearly every penny of its property tax revenue to bond and pension debt.
“It’s a very expensive price, and the price does reflect the fragility of Chicago’s financial situation,” said Richard Ciccarone, president and CEO of Merritt Research Services, a municipal bond analysis firm.
Because of the higher cost of the bonds, the city was forced to turn to short-term borrowing — akin to the household use of a credit card — to pay off the remaining $126 million. City finance officials said in a presentation to investors that Chicago does not have enough tax dollars earmarked for bond debt available in the near future to cover the whole $800 million.
But short-term borrowing has become costly as well. The annual rate the city will pay on the short-term debt is more than many cities pay on 30-year bonds.
Finance officials expect to roll the $126 million in short-term loans into a long-term bond issue later this year — a move that likely will extend payments over a longer period at an even higher overall cost. For the moment, it will push the city’s outstanding short term debt, which was capped at $200 million under Mayor Richard M. Daley, to $714 million.
The four variable-rate bonds being paid off with the new borrowing were originally issued by Daley and were among billions of dollars of borrowing by the six-term mayor that have left the city with burdensome annual debt payments — even as some of the money went for short-term items such as software and spare parts for vehicles.
The deals were part of alternative financing arrangements that banks pitched to many governments in the early 2000s as a cheap way to borrow money. The interest rates fluctuated but remained low because investors could cash out at any time.
For that reason, these variable-rate bonds — unlike traditional fixed-rate debt — required a letter of credit from an outside bank willing to buy back the bonds at any time from investors who wanted to dump them. The city agreed that it would keep its debt rating above junk status in order to maintain the letter of credit.
The city made the same promise to banks in interest-rate swap agreements, derivative instruments that made up the second part of the two-pronged alternative financing deals. Those contracts, which provided for an exchange of interest payments between the city and banks, were aimed at stabilizing the fluctuating cost of variable-rate bonds.
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Emanuel plans to pay off all of the city’s taxpayer-backed variable rate debt and related swaps by early summer.
Reducing the city’s portfolio of alternative debt and derivatives — and with it the threat of banks suddenly demanding large sums — is part of a restructuring plan Emanuel unveiled in late April in an effort to stabilize the city’s shaky finances.
As part of that plan, the city also announced Wednesday it will restructure a fifth variable-rate bond, amounting to $112 million. The city is expected to set prices on that deal June 3.
The mayor also has promised to phase out his use of “scoop and toss,” the practice of using new debt — including $220 million this year — to push off old debt and push debt payments deeper into the future at great cost. The four bonds restructured Wednesday will all be paid back by 2042, the same final due date they had before.
The city’s financial instability — as well as its junk rating — is driven by its massive pension debt, the result of years of putting off payments to the city’s pension funds. Moody’s latest downgrade cited an Illinois Supreme Court ruling making it seem less likely the city would be able to reduce pension costs.
Documentation for one of the four old bonds being restructured contains a reminder of just how creative Daley became in avoiding those pension costs. Among the ways the city planned to use the borrowed money under Daley: making pension contributions.