(Bloomberg) -- Chicago may join the bond refinancing bonanza.
The finance committee of its city council on Tuesday approved the sale of as much as $1.5 billion of debt, seeking to seize on interest rates that are holding near a more than half-century low to pay off previously issued bonds. Mayor Lori Lightfoot is wagering the third-biggest U.S. city can save about $210 million by refinancing debt, helping to close the $838 million budget shortfall she’s facing.
The slide in interest rates this year has stoked activity in the $3.8 trillion municipal-bond market, where new debt sales have jumped by about 21% in 2019 as the Federal Reserve started easing monetary policy for the first time in over a decade.
Rates have fallen so much that states and cities have even been refinancing debt by selling taxable bonds, allowing them to at least temporarily revive a tactic known as advanced refunding that largely disappeared after President Donald Trump’s 2017 tax overhaul pulled the subsidies from such deals.
“It’s a good idea to refund these bonds,” said Vikram Rai, head of municipal strategy for Citigroup Inc., the second largest underwriter of municipal securities. “The city needs to bring down its debt service costs.”
Despite the continued influx of cash into municipal-bond mutual funds, the stepped up pace of borrowing has created headwinds for the market. Tax-exempt debt has delivered a return of about 6.7% this year, compared with 7.1% for Treasuries and 13.5% for corporate bonds, according to Bloomberg Barclays indexes.
Yet Chicago’s bonds may draw widespread interest from investors eager for higher yielding securities, given that the city’s junk-grade rating from Moody’s Investors Service leaves it paying bigger interest penalties than other local governments. That’s largely because Chicago’s approximately $30 billion debt to its pension plans is exerting a major drag on the government’s finances, with the annual projected pension contribution jumping to $1.68 billion in 2020, according to city documents.
Rai said that demand for high-yield securities is outpacing supply, to the potential benefit of Chicago. “In this market, there is enough demand,” he said. “Credit spreads are so tight.”
Chicago hasn’t decided whether its refinancing would be done through the sale of taxable or tax-exempt debt, and the deal still needs to be approved by the full city council. Taxable city bonds due in 2033 are trading for yields of 5.3%, or about 3.5 percentage points more than top rated debt, while tax-exempt debt due in 2035 is yielding about 2.67%, about a percentage point more than the benchmark.
(Adds deal approved in second paragraph.)
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