Chicago Losing AA Rating as Daley Deals Fail to Offset Deficits

Monday, September 13, 2010

Chicago’s next mayor will take over a city that is almost out of cash after Richard M. Daley spent most of the $3.5 billion gained from leasing parking meters, garages and a 7.8-mile elevated toll road.

The third-biggest U.S. city by population projects a $654.7 million deficit in a $3.39 billion budget for 2011, a July 30 report shows. Daley balanced this year’s $3.12 billion budget partly with reserves. If he uses lease funds to fill the 2011 gap, Chicago will be left with $121 million, enough to run the municipality for two weeks, according to data compiled by Bloomberg.

“It almost will disappear by the time the mayor leaves office,” said R. Eden Martin, president of the Commercial Club of Chicago, a civic group. “Cutting $600 million is going to be a catastrophe. It is going to be very, very painful.”

In July, the city projected a year-end surplus of $2.9 million on Dec. 31, less than 1 percent of next year’s projected budget, according to financial statements. Daley, 68, announced Sept. 7 that after 21 years in office he won’t seek another term. When its reserves are gone, the city may have to raise taxes or cut more spending.

“There’s still a lot of this attitude of spending for today and letting the next generation pay for it,” said Alan Schankel, director of fixed-income research for Janney Montgomery Scott LLC, a money-management company based in Philadelphia. “Whoever takes over will have their hands full.”

Pete Scales, a city spokesman, didn’t respond to e-mails seeking comment.

Credit Rating Cut

Shrinking reserves led Moody’s Investors Service to cut Chicago’s credit rating on $6.8 billion of general-obligation debt, to Aa3, the fourth highest, from Aa2, before an August bond sale. The city’s debt burden rose to $5,399 per resident last year, bond offering documents show, topping those for all U.S. states including Connecticut, the highest, at $4,859, according to Moody’s data.

In the August offering, the city’s relative cost of borrowing $164.1 million for schools surged from January, based on the 222 basis-point difference between the yield on the taxable issue and a benchmark U.S. Treasury bond last month. That compared with a 131 basis-point spread, or premium, in January, according to data compiled by Bloomberg. A basis point is 0.01 percentage point.

“They’re a AA rated borrower that is trading as if it was rated A,” said Richard Saperstein, managing director at Hightower Advisors Treasury Partners in Chicago who helps oversee $9.5 billion in assets. “This means they’re in line for a downgrade. The market is telling you something.”

Emanuel Interest

The chance to rule Chicago City Hall has attracted interest from White House Chief of Staff Rahm Emanuel, 50, whose current boss also began his political career in Chicago. Emanuel, a Democrat and former aide to President Bill Clinton, was a Chicago congressman before entering the administration of President Barack Obama. Nov. 22 is the last day for candidates to file papers for the election.

Daley, the son of the late Mayor Richard J. Daley, first won election in 1989 to finish the term of the late Harold Washington. He will complete a sixth term in May. Under his tenure, City Hall seized control of Chicago’s schools, demolished much of its public housing, survived corruption scandals and sought unsuccessfully to host the 2016 Olympics.

The mayor drew praise from business leaders for bringing Boeing Co. headquarters to Chicago after takeovers cut the number in the city. He oversaw the quieting of racial tensions, the creation of the 1,500-acre lakefront Millennium Park and the landscaping of miles of boulevard medians to beautify streetscapes.

Drivers on Hook

Daley also has been selling the right to run city assets, starting in 2005 with the 7.8 mile (12.5-kilometer) Chicago Skyway Bridge toll road, and using the proceeds to balance budgets. The city also leased garages and in 2008 cut a $1.15 billion deal to let a Morgan Stanley-led partnership run its parking meters.

While the sales brought immediate cash to city coffers, Bloomberg News reported in August that recent financial documents show drivers will pay at least $11.6 billion in parking-meter charges in the next 75 years, or 10 times what the city received for the lease, according to documents from the Morgan Stanley partnership.

The New York bank, Abu Dhabi Investment Authority and Allianz Capital Partners may earn a profit of $9.58 billion before interest, taxes and depreciation, according to documents for a planned $500 million private note sale in July by their Chicago Parking Meters venture. The partnership, which postponed the transaction, runs 36,000 city meters.

Budget Gaps

Originally, some funds from the long-term leases of the meters, garages and the Skyway, which connects the city to Indiana, were supposed to be invested to replace revenue the assets produced. In recent years, as the longest U.S. recession since the 1930s raised unemployment, hammered the housing market and slowed revenue, Daley and city officials have used more of the lease funds to close budget gaps.

Chicago’s finances also are being challenged by unfunded pension costs and union contracts that limit the city’s ability to cut expenses.

“The city sold its future revenue, and has spent the money and doesn’t have any reserves,” said Hightower’s Saperstein. “It’s robbing future revenue that will be critically needed.”

Once the city has exhausted the lease money, it may have no alternative but to slash services or raise taxes. Chicago already has one of the highest combined state and local sales- tax rates among U.S. cities, at 10.25 percent, according to the Tax Foundation in Washington. That compares with 8.875 percent in New York and 9.75 percent in Los Angeles, the two biggest U.S. cities.

“Expenditures are exceeding revenues,” said Edward Damutz, a Moody’s analyst in Chicago. “At what point do you decide you have cut to the bone and are no longer providing promised services? Then revenue becomes part of the equation.”