Pension woes hit trading in Chicago's bonds

CHICAGO Wed Aug 14, 2013 6:01pm EDT

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CHICAGO Aug 14 (Reuters) - Chicago bond prices are falling in the U.S. municipal bond market as investors fret about the city's growing public pension burden.

Trades of certain Chicago general obligation bonds this week have pushed the city's so-called credit spread over Municipal Market Data's benchmark yield scale for triple-A-rated debt to more than 190 basis points in the intermediate maturity range from levels around 160 basis points.

On Wednesday, Chicago GO bonds with a 5 percent coupon that mature in January 2025 traded at 99.565/99.465 to yield just above 5 percent. They have a spread of just over 191 basis points over MMD's scale. The same bonds traded at a spread of 171 basis points on Aug. 8.

Chicago's credit spread exceeds the one for Illinois, which has its own massive pension problem. The spread for the state's 10-year GO bonds, which was 155 basis points in the week ended Aug. 2, widened in the latest week to 165 basis points.

Tim McGregor, director of municipal fixed income at Northern Trust in Chicago, pointed to continued inaction on pension reform as the reason for the wider spreads for Illinois and Chicago bonds.

"People who are not addressing pension issues are going to be penalized by the market," he said.

Chicago, the third largest U.S. city, is bracing for a big spike in pension payments because the the city has to comply starting in 2015 with a state law that requires it to increase pension payments for two pension funds for public safety workers to bring their funding level to 90 percent by 2040.

A financial analysis released by Chicago Mayor Rahm Emanuel on July 31 projects the city's budget gap of $338.7 million for fiscal 2014 will climb to nearly $995 million in fiscal 2015 and $1.15 billion in fiscal 2016.

The city's pension payments are expected to grow from $479.5 million in 2014, which begins Jan. 1, to about $1.07 billion in 2015 and $1.11 billion in 2016, according to the financial analysis.

Shawn O'Leary, senior research analyst and manager at Nuveen Investments in Chicago, said a multi-notch rating downgrade of Chicago by Moody's Investors Service focused the market's attention on the city's pensions.

Moody's on July 17 slashed Chicago's Aa3 GO rating to A3, just a notch above the BBB level, due to the city's large and growing pension liabilities and related budget pressures. The rating agency also placed a negative outlook on the lower rating due to the expected spike in the city's pension payments.

Chicago reported a $19 billion unfunded liability for its four pension funds at the end of 2012, but Moody's pegged the liability at $36 billion using more conservative assumptions.

A rating drop to the BBB level, the low end of investment grade, would not immediately label Chicago's debt as high yield, according to O'Leary.

"If they fail to find a path to pension reform, it could get there," he added.

He said Chicago is telling investors that it is waiting for Illinois to enact pension reform for the state retirement system, which could then set a precedent for the city to follow.

MORE BOND SALES TO COME

A special legislative panel has been meeting since its creation in June to reach a compromise on taming Illinois' $100 billion unfunded pension liability that is squeezing out funding for core state services such as education and health care.

Any proposal from the committee that is ultimately enacted into law will likely face legal challenges by public labor unions and others as the Illinois Constitution contains strong protection for state and local government public employee retirement benefits.

Failure by lawmakers to pass pension reforms has left Illinois with the lowest credit ratings among states at the bottom of the A level.

Chicago could face another rating cut. Fitch Ratings in June put the ratings on nearly $8.7 billion of Chicago's debt, including AA-minus-rated GO bonds, on a watch list for a possible downgrade, citing the city's growing unfunded pension liability.

Standard & Poor's Ratings Services rates Chicago's GO bonds A-plus with a stable outlook.

Big pension problems and widening credit spreads are not deterring either Illinois or Chicago from selling debt in the $3.7 trillion muni market.

Other large municipal bond issuers have lower credit spreads. New York City was just 42 basis points, while California's was 47 basis points. Puerto Rico has the widest spread among major municipal debt issuers tracked by MMD at 320 basis points.

Tom Alexander, a Chicago spokesman, said the city is planning to sell general obligation bonds later this year.

"Markets are constantly moving so we adjust our financing plans to reflect market realities," he added.

Illinois has sold $3 billion of debt so far in 2013, including a June sale of $1.3 billion of GO bonds that Governor Pat Quinn said will saddle taxpayers with an additional $130 million in debt service costs over 25 years because investors are demanding hefty yields from the state.

"Bond sales for the balance of the calendar year are being reviewed. Nothing firm at this time," said John Sinsheimer, the state's capital markets director.

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