Chicago mulls borrowing that Puerto Rico rejected as too risky

(Bloomberg) — Chicago is considering selling a type of debt that's fallen out of favor in other municipalities because it saddles taxpayers with higher costs by delaying payments.

Mayor Rahm Emanuel proposed issuing $500 million of bonds this week in an ordinance that would permit the use of capital appreciation bonds, where borrowers postpone interest and principal payments into one big sum at the end of the term. Emanuel's pitch also allows for the more common current interest bonds, which the city said it expects to use.

Chicago is struggling to plug its deficit and $20 billion of unfunded pension liabilities. Emanuel's move would give the third-most-populous city a means of borrowing without having to face the costs right away.

“Given where Chicago is at, it does seem like it's a way to kind of push off debt payments out longer, which from a credit standpoint is not favorable,” said Michael Johnson, managing partner at Gurtin Fixed Income Management, which oversees $9.5 billion of munis in Solana Beach, California. “It's probably not the best idea for them right now.”

Texas restricted the use of CABs in June and California has limited them since 2013. The Puerto Rico Electric Power Authority dismissed a bondholder plan last week to restructure its debt using capital appreciation bonds, citing the disproportionate risks.

ABUSIVE DEBT

If approved, the ordinance would give the city “the flexibility” to use capital appreciation bonds, but it also allows for the use of current interest bonds, which is what Chicago expects to sell, Molly Poppe, a city spokeswoman, said in an e-mail. Chicago hasn't issued capital appreciation bonds since 2009, she said.

Use of capital appreciation bonds have come under fire in Texas and California, where lawmakers have passed legislation to limit their use. Former California Treasurer William Lockyer called the debt “abusive” because it passes on large payments to future generations.

“They increase the total cost and lower flexibility going into the future,” said Steve Murray, a senior director at Fitch Ratings. “They can limit future borrowing ability.”

Emanuel also proposed selling $125 million of wastewater revenue bonds to fund swap termination payments, Poppe said. A separate ordinance would authorize $2 billion in bonds for O'Hare International Airport, including $1.7 billion of refunding for savings, and about $300 million of new money for capital projects and interest, according to Poppe.

Photo by ThinkStock An ordinance would give Chicago "flexibility" to use capital appreciation bonds.

Chicago mulls borrowing that Puerto Rico rejected as too risky