Chicago’s Biggest Bondholders Torn on City’s Future: Muni Credit

The biggest holders of Chicago general-obligation bonds are diverging on the city’s outlook as it stares down $590 million in extra pension payments. State lawmakers invoke Detroit as the consequence of inaction.

A month after Mayor Rahm Emanuel won the legislature’s approval of a plan to stabilize two of the city’s four pension systems, Governor Pat Quinn hasn’t signed the measure into law, objecting to the possibility that city officials would raise property taxes. The delay is reminiscent of the political gridlock that plagued Illinois for years as its credit rating sank.

While Nuveen Asset Management and Vanguard Group Inc. say they prefer insured Chicago bonds, Wells Capital Management contends the city’s economy is strengthening. Rating companies are also divided on the city as it faces almost $20 billion in unfunded pension promises. Standard & Poor’s grades Chicago A+, three steps above Moody’s Investors Service.

“Chicago will ultimately address their problems of high legacy costs; it’s just more of a timing issue -- that action in Illinois can often take longer than one would expect,” said Joseph Gankiewicz, an analyst at BlackRock Inc., which oversees $108 billion in municipal debt.

With $127 million of Chicago bonds, New York-based BlackRock is the sixth-biggest holder, data compiled by Bloomberg show.

Who’s Next?

The uneasiness surrounding Chicago reflects the impact of Detroit’s record bankruptcy in July and Puerto Rico’s descent into junk status. Speculation that pension underfunding, population loss and debt load -- all present in Chicago -- would cause Puerto Rico to default prompted an unprecedented flight from the Caribbean commonwealth’s securities starting about a month after the Motor City’s filing.

Chicago has the largest pension burden among the most-indebted localities, according to Moody’s. The company grades Chicago general obligations Baa1, three steps above junk and the lowest among the 90 most-populous U.S. cities except for Detroit.

Of all states and localities, the combination of Chicago and Illinois probably cause the most investor anxiety after Detroit and Puerto Rico, said John Miller, co-head of fixed income at Nuveen, which oversees about $90 billion of munis. The Chicago-based company said it owned about $279 million of city general obligations as of March 31. All the debt carries insurance, Miller said.

Mirror Image

Illinois officials grappled with pension deficits for years on the way to becoming the lowest-rated state. Yet after lawmakers passed a fix in December, the state earned its lowest borrowing costs since 2009.

The confidence didn’t extend to Chicago when it borrowed $883 million in March. The deal’s longest-maturing tax-free debt, due in January 2036, priced to yield 5.18 percent, or 1.68 percentage points above benchmark munis.

That spread was more than double the level when the nation’s third-most-populous city issued general obligations in May 2012. The 22-year portion of that sale yielded 0.78 percentage point more than AAA debt.

Over that period, S&P’s rank hasn’t changed, while Moody’s dropped the city four levels.

‘Better Situation’

Emanuel, who in 2011 succeeded 22-year incumbent Richard M. Daley after serving as chief of staff to President Barack Obama, has rejected comparisons to Detroit. So has S&P, which defended its grade in a February study titled “Chicago Seems Unlikely To Suffer Detroit’s Fate.”

“Chicago has a very robust economy relative to Detroit,” including one of the country’s largest airports and a rail hub, said Lyle Fitterer, who helps oversee $31 billion of munis at Wells Capital in Menomonee Falls, Wisconsin. The firm holds $298 million of Chicago debt, second-most.

“From an economic perspective, we would argue that Chicago is in a better situation than two or three years ago -- we think Moody’s is looking in the rear-view mirror,” Fitterer said. The company rates Chicago internally the same as S&P, he said.

State lawmakers cited Detroit as a rationale for passing city pension measures last month.

During floor debate April 8, House Republican Leader Jim Durkin warned that the pension burden threatens financial stability and said he didn’t want to “see the city of Chicago fall in line with Detroit, New York in the 1970s.”

Quinn’s Objection

Quinn, a Democrat facing re-election this year, hasn’t acted on the legislative solution, out of objection to property-tax increases that would help pay for part of the pension fix. The governor has until early June to decide on the bill.

“We cannot rely on a regressive property-tax system,” he told reporters in Chicago April 28. “We’re over-relying on that now.”

Even if Quinn signs the bill, Chicago faces a $590 million additional payment for retirement obligations next year unless state lawmakers restructure the pension funds.

Kelley Quinn, a spokeswoman for Emanuel, didn’t respond to an e-mail seeking comment.

State lawmakers are working on the fiscal 2015 budget, which includes Quinn’s proposal to extend personal and corporate income-tax increases approved in 2011, and gives annual $500 tax rebates to property owners.

Vanguard’s Stance

The cloud over Chicago’s pensions has led Vanguard to hold fewer of the city’s bonds than its benchmark, said Chris Alwine, head of munis at the Valley Forge, Pennsylvania-based money manager. It holds the fourth-most Chicago general obligations.

Alwine said Vanguard owns $157 million of Chicago bonds, with $23 million uninsured, out of $130 billion of total munis.

The company “will remain cautious on Chicago until we see substantive progress in addressing its pension challenges,” he said via e-mail.

FMR LLC, parent of Fidelity, is the largest owner of Chicago general-obligation bonds, according to Bloomberg data. Franklin Resources is fifth, Allianz SE is seventh, Chubb Corp. is eighth, Bank of New York Mellon Corp. is ninth and Continental Casualty Co. is 10th.

Sophie Launay, a spokeswoman at Boston-based FMR, declined to comment, as did Mark Greenberg, a spokesman for Warren, New Jersey-based Chubb. Stacey Johnston Coleman at Franklin, Susan Rivers at BNY Mellon and Jennifer Martinez-Roth at Continental parent CNA Financial Corp. said no one was available to comment.

Agnes Crane, a spokeswoman at Allianz subsidiary Pacific Investment Management Co., didn’t return a phone call seeking comment.

Holdings Breakdown

The table below lists the companies with the biggest holdings of Chicago general obligations.

For Nuveen and Vanguard, the figures are from the companies. Data for the other eight firms are from the most recent company filings to Bloomberg, and exclude derivatives and debt that’s fully pre-refunded or escrowed to maturity. Values for securities were calculated as position multiplied by market price. Pricing figures are from either Municipal Securities Rulemaking Board trade data or Bloomberg Valuation data.

Rank                           Debt Holder    (Millions)
1                                  FMR LLC          $375
2                        WELLS FARGO & CO.          $298
3                 EEN ASSET MANAGEMENT LLC          $279
4                      VANGUARD GROUP INC.          $157
5                  FRANKLIN RESOURCES INC.          $145
6                           BLACKROCK INC.          $127
7                               ALLIANZ SE           $97
8                              CHUBB CORP.           $93
9            BANK OF NEW YORK MELLON CORP.           $87
10                CONTINENTAL CASUALTY CO.           $59

SOURCE: Bloomberg

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