Dramatic Slowing in Municipal Defaults So Far this Year

Here's some good news for muni bond investors worry about the impact of Trump administration tax cuts: Municipal bond defaults have slowed dramatically, reports Matt Fabian's Municipal Market Analytics.

In the first six weeks of the year, only six issuers have filed first notices of impairment, he finds, compared to 25 in the first two months last year and 30 the year before.

Fabian writes Friday:

This is a distinct slowing of credit problems that reasonably follows: 1) somewhat stronger economic trends; and 2) materially stronger demand for high yield securities (which permits struggling project debt to be restructured prior to an actual impairment developing). These results are constructive generally for municipals and specifically for continued high yield performance.

The benchmark-tracking iShares National Muni Bond ETF (MUB) rose slightly Friday to $108.30. It is up 0.2% this year

Surging Muni Yields in Chicago Send Warning Signal

Chicago's sale of $900 million general obligation bonds last week came at a high price and has some muni strategists worried about what comes next.

Matt Fabian of Municipal Market Analytics wrote to clients Tuesday:

The deep price concessions made by Chicago to complete its $900M GO sale last week are a point of concern both for the city and for the market at large. Yields near or north of 6.0% represent spreads more than 100bps wider than the city’s last GO sale in January 2016 and are roughly double benchmark 5% AAA nominal yields.

He notes that the city's bonds are trading near Chicago Public Schools, which he thinks is appropriate, but it isn't the way investors typically see things.

The latest pricing has him worried enough that it reminds him of Puerto Rico, circa 2013, when the Commonwealth started to lose access to capital markets. He writes:

The high nominal and relative yield levels draw comparison to PREPA’s beginning-of-the-end 7%’s in 2013, and raise concerns that the city is in the first stages of losing economic market access. MMA does not believe that that has to be the case; however, perceptions of insolvency can be difficult to shake without convincing and sustained positive credit momentum.

City sells $1.16B in bonds, but pays a heavy price for CPS crisis

Chicago sold $1.16 billion in general obligation bonds Thursday, but paid a heavy price for a school financial crisis made worse by Gov. Bruce Rauner’s veto of a bill promising $215 million in pension help.

The “spread” between Chicago’s interest rate and the interest rate the city would have paid if it had a AAA bond rating ranged from 3.3 percent to 3.5 percent, according to Matt Fabian, a partner at Municipal Market Analytics.

Fabian called it the “worst spread” in recent memory on a city bond deal.

Even more surprising was the fact that the interest rate on Chicago’s general obligation bonds was a “full percentage point” higher than it was a year ago — before the City Council approved Mayor Rahm Emanuel’s plan to slap a 29.5 percent tax on water and sewer bills to save the largest of four city employee pension funds.

Market factors beyond the city’s control were working against the city.

The recent interest rate increase and prospects for higher inflation under President-elect Donald Trump meant the “universe of potential players has shrunk,” Fabian said. There’s more yield in “safe” bonds that carry a AA or AAA rating, he said. Fewer investors “need to reach to get the added yield” of a Chicago bond.

But the overriding factor was the financial crisis at the Chicago Public Schools.

“Investors are afraid that CPS might be pulled into bankruptcy in some way or that a new bankruptcy provision might be created or that CPS might have to default on its bonds. And that’s going to directly affect the city,” Fabian said, arguing that the CPS penalty would cost taxpayers millions over the life of the bonds.

There is little doubt that Rauner’s veto of the teacher pension bill “chased away investors and made the universe of buyers smaller,” Fabian said.

“CPS can’t fix its budget problems without the state’s help. And the state, through the governor has shown no interest in providing it,” he said. “Until a plan for CPS materializes, these are the kinds of interest rates the city and the district are gonna have to pay.”

The governor’s veto and the continuing budget stalemate in Springfield were not the only concerns for investors.

So was the $1.16 billion borrowing itself. It includes $440 million in “scoop-and-toss” borrowing, $105 million more than previously planned, that extends for another generation debt that should be retired today.

It also includes $225 million to bankroll settlements and judgments against the city — $100 million more than previously planned.

Emanuel has promised to eliminate both dubious financial practices by 2019. That’s also the deadline he set for eliminating a structural deficit that’s already 80 percent smaller than the one he inherited.

“The fact that this bond sale was still funding scoop and toss and that . . . they’re borrowing to pay interest on the these bonds — those are not the things that healthy cities do,” Fabian said.

“The mayor has made progress. But the city budget is still a mess. . . . The city needs another year or two at least to fully eliminate its budget gap,” he said. “In a few years, if everything else works out, these borrowing costs will begin to come down.”

The Emanuel administration tried to put the best possible face on the transaction, noting that the bonds were “three times over-subscribed” and attracted 145 investors.

“The city continues to address our financial challenges and work to end bad financial practices of the past, and these bonds represent a critical milestone in this effort,” Chief Financial Officer Carole Brown was quoted as saying in an emailed statement.

“This deal represents our final borrowing for scoop and toss, following through on Mayor Emanuel’s commitment to end this practice by 2019. This is also our last borrowing for routine settlements and judgments, continuing the Mayor’s commitment to end the legacy of using long-term debt to pay for operating expenses.”

Moody’s: Bankruptcy, Skipping Pension Payments Options for CPS

The credit rating agency Moody’s Investors Services outlined three “painful” options for how  Chicago and its public school system could get out of money trouble.

The school district could consider another property tax levy to pay off its growing debt or skipping its pension payment to the Chicago Teachers’ Pension Fund, Moody’s says in a pair of reports issued to potential investors Thursday. 

The boldest option was floated as a last resort: Chicago Public Schools should consider seeking state authority to file for bankruptcy. 

Bankruptcy and skipping a pension payment would require changes to state law and bankruptcy has been raised by Gov. Bruce Rauner and Illinois Republicans in the past, but was quickly dismissed by Mayor Rahm Emanuel and others. A spokeswoman for the school district on Thursday said all three options would create more financial problems and would be bad for city taxpayers. 

These reports come one week before the city plans to borrow more money to cover its debt payments and one month after Mayor Rahm Emanuel sent a letter to the credit rating agency accusing it of bias. The city hasn’t requested a credit rating from Moody’s in two years.

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“It has become increasingly clear that Moody’s rating methodology and agenda are far from objective and independent,” Emanuel wrote in the December letter. “This is not to say that the City should be rated AAA, but… your current rating does not accurately reflect the City’s credit or our ability to pay debt service when due.”

The report about the City’s finances does acknowledge some of the steps Emanuel has taken to improve both the city’s and the school system’s finances. Specifically, it notes the additional property tax levies that have been created to fund the pensions of city workers, police officers and public school teachers. 

But, the report says, “contributions will remain insufficient to keep reported unfunded liabilities from growing for at least 15 more years.”

The reports issued Thursday are meant to help potential investors decide whether to lend Chicago money.

Matt Fabian, a partner at Municipal Market Analytics, says the city is on the right track, but it’s delicate.

“In general, the city is doing the right things,” Fabian says. “But it’s just started doing the right things. And it’s depending on time to give it more financial flexibility. Maybe it will have that time, and maybe it won’t.” 

He says risks faced by the city and its school system are probably the top two conversations in his professional world.

“The problem with Chicago is not so much the economy, and it’s not even really the pensions, long-term,” he says. “It’s the political issues.”

For instance, raising taxes too quickly could trigger a political backlash, which Moody’s also acknowledges in its report. But going slowly increases the risk that something else — like a recession — could make the financial problems worse.

Dan Weissmann contributed reporting for this story.

Six years after Daley, Emanuel still using high-cost borrowing practices

Mayor Rahm Emanuel is pitching Wall Street investors on the latest city borrowing plan, a $1.2 billion package that, like previous versions, pushes hundreds of millions of dollars of debt into the future at higher costs to taxpayers.

The mayor is continuing scoop-and-toss borrowing, which involves paying off old bonds with the proceeds from new ones — a practice akin to taking out another mortgage on a house to pay off the old mortgage, kicking payments down the road. An Emanuel budget spokeswoman said this year marks the last scoop-and-toss bond issue.

The administration also said it'll be the last time the city will borrow money to pay for a portion of routine legal settlements and judgments, adding millions in interest to what are short-term expenses. Some of that debt will take the form of taxable bonds, which carry higher interest rates. That's because the federal government doesn't allow the issuance of tax-free bonds for what are considered yearly operating expenses.

Kathy Bergen and Stacy St. Clair

Chicago's Washington Park was nearly empty on a recent Friday afternoon as Bronzeville resident Rosemary Jarrett power-walked her usual five laps around the perimeter of the graceful meadowland where a temporary Olympic stadium could have risen this summer.

The school crossing guard shook her head...

Chicago's Washington Park was nearly empty on a recent Friday afternoon as Bronzeville resident Rosemary Jarrett power-walked her usual five laps around the perimeter of the graceful meadowland where a temporary Olympic stadium could have risen this summer.

The school crossing guard shook her head...

(Kathy Bergen and Stacy St. Clair)

Beyond that, the mayor plans to borrow a to-be-determined amount to cover some of the initial interest payments on the new debt the city is taking out, which adds to the overall cost. It's the equivalent of taking out a loan to pay the initial interest on a mortgage.

Emanuel inherited the costly borrowing practices, detailed by the Chicago Tribune in its 2013 "Broken Bonds" investigation, from predecessor Richard M. Daley. Emanuel, now on his sixth spending plan, has used the techniques to prop up a sagging City Hall budget. In 2015, the mayor promised to end the costly financial moves by the end of his second term in 2019.

The administration's plans call for pricing the bonds on Jan. 18-19, when the market will determine the interest rates, and closing on the deal Feb. 1, Emanuel's Chief Financial Officer, Carole Brown, said in a web-based "roadshow" used to pitch the bonds. City finance officials also plan to meet with investors in Chicago, Boston and New York before the bonds are sold to make further pitches, a common tactic Chicago and other major cities have begun to use in recent years.

The city is likely to pay relatively high interest rates because municipal bond market rates recently increased, and continuing financial problems at Chicago Public Schools and the state of Illinois has investors concerned, said Matt Fabian, a partner at Concord, Mass.-based Municipal Market Analytics.

Fabian also said buyers would look more favorably on city debt if it stopped using "budget gimmicks" like scoop-and-toss and borrowing to pay initial interest payments "instead of just talking about how they're going to stop."

While Mayor Rahm Emanuel has reduced Chicago's use of borrowed money to plug budget holes, records show he continues to rely heavily on the practice, devoting nearly half of the $300 million in long-term bond funds spent over the past two years to short-lived expenditures.

As the City Council prepares...

While Mayor Rahm Emanuel has reduced Chicago's use of borrowed money to plug budget holes, records show he continues to rely heavily on the practice, devoting nearly half of the $300 million in long-term bond funds spent over the past two years to short-lived expenditures.

As the City Council prepares...

But he added that "the municipal market has come to see and talk about Chicago as a bit of a success story" after Emanuel set in motion plans to contribute hundreds of millions of additional dollars a year to its pension plans for police officers, firefighters, city workers and laborers.

At Emanuel's urging, the City Council in recent years increased telephone fees for emergency service, dramatically increased property taxes and enacted a new tax on city water and sewer service to help fund higher contributions to the four pension funds.

But there's uncertainty about how the city will come up with hundreds of millions of additional dollars in the early- to mid-2020s that will be needed to make even higher contributions to those funds in an effort to prevent them from running out of money. And the plans for the municipal workers' and laborers' funds have yet to be approved by a state government mired in partisan gridlock.

Nevertheless, Wall Street bond rating agencies have changed the city's debt outlook from negative to stable based on the efforts underway to stabilize the pension funds, all of which were at risk of going broke in the 2020s even if the city's general bond ratings remain low. That could result in the city paying lower interest rates than they otherwise would have when the bonds go to market this month.

Richard Ciccarone, president and CEO of Merritt Research Services, said interest rates also could go higher because of "intangible" factors not directly related to city finances, like a recent "60 Minutes" segment on Chicago's spiking violent crime rate. "Those kind of things don't help, even though they are very indirectly related to finance," he said.

Mayor Rahm Emanuel said Monday that cash-strapped Chicago Public Schools is likely to borrow against a $45 million property tax increase he’s proposed in his budget for school construction.

The CPS tax hike is part of the record $588 million property tax increase aldermen are expected to approve...

Mayor Rahm Emanuel said Monday that cash-strapped Chicago Public Schools is likely to borrow against a $45 million property tax increase he’s proposed in his budget for school construction.

The CPS tax hike is part of the record $588 million property tax increase aldermen are expected to approve...

But Ciccarone praised the mayor's efforts to fix the pension systems, reduce the city's annual budget funding gaps, rely less on short-term borrowing and beef up city budget reserves. "The city moved forward in 2016 on making real incremental progress," he said.

The City Council signed off last year on the latest round of borrowing, but the scoop-and-toss total is about $100 million higher than Emanuel finance aides told aldermen was in the works. The dollar amount went up because plans to refinance about $100 million in debt to save money were no longer possible after a recent rise in municipal bond interest rates, budget spokeswoman Molly Poppe said. The city still plans to refinance about $25 million.

Some specifics about the $1.2 billion borrowing plan:

•$440 million in scoop-and-toss borrowing, a long-term delay tactic that adds millions of dollars in interest costs to be paid by taxpayers over the next 20 years.

•About $225 million to pay legal settlements and court judgments. Other cities with sounder finances pay such costs without borrowing that adds millions of dollars to the taxpayer tab.

•About $405 million for construction projects and equipment, including new police vehicles.

Poppe defended the city's plans to borrow money to cover some of the initial interest costs, saying that's "common practice" in cases where cities don't anticipate the construction projects financed by the borrowing to be completed for a while. That way, "debt service expense does not begin until the project is operational and benefiting communities," she said.

Heather Gillers and Hal Dardick

Mayor Rahm Emanuel has reduced spending and increased fines, fees and certain taxes to shrink the chronic budget deficits left over from his predecessor, Richard M. Daley.

But four years after taking office, Emanuel still at times resorts to Daley's questionable budget tactics as the mayor struggles...

Mayor Rahm Emanuel has reduced spending and increased fines, fees and certain taxes to shrink the chronic budget deficits left over from his predecessor, Richard M. Daley.

But four years after taking office, Emanuel still at times resorts to Daley's questionable budget tactics as the mayor struggles...

(Heather Gillers and Hal Dardick)

Laurence Msall, president of the nonpartisan Civic Federation budget watchdog group, lauded Emanuel's pledge to end borrowing for scoop-and-toss and legal settlements and judgments, but expressed some skepticism as to whether the mayor could keep the promise.

"Even if the city is able to end most borrowing for operations by 2019, it faces significant financial challenges that could make it difficult to maintain its commitments in the future," said Msall, who called on Emanuel to "present a plan" for covering future debt service payments and paying off legal settlements and judgments.

hdardick@chicagotribune.com

Uptick in Muni Defaults Could Hurt More Investors in 2017

By Amey Stone

While the uptick in municipal bond defaults isn't that high, it could be more painful for municipal bond investors in the coming year, writes Matt Fabian of Municipal Market Analytics in his latest report on default trends Friday.

That's because bond insurance isn't nearly as common now as it used to be. "Credit trauma is likely to harm bondholders more directly this year and in the future," he writes.

Last year saw 65 first-time payment defaults, up from 60 in 2016. Eight of 2016 defaulters were Puerto Rico issues. However, the number of "impaired" credits declined in 2016.

He sums up the outlook:

The drop in impairments bolsters the alternative scenario outlined in the last issue of DEFAULT TRENDS: that municipal defaults are not necessarily beginning to leg higher but are instead experiencing modest volatility around a relatively low baseline. Nonetheless, MMA is comfortable advising subscribers to approach the new year expecting an uptick in default activity as emergent state budget gaps belie tax and fee revenue weakness across the government spectrum and, because of more aggressive high yield underwriting in 2016 (see OUTLOOK 1/3/17) a large universe of unseasoned project financings is poorly prepared for economic setbacks.

The iShares National Muni Bond ETF (MUB) climbed to $108.35 by Friday afternoon, a 27 cent gain so far in 2017.