Chicago’s Next Mayor: How Wall Street Sees the Outcome

(Bloomberg) -- Chicago’s election to replace Mayor Rahm Emanuel, a contest closely watched by Wall Street, is headed for a historic runoff between former federal prosecutor Lori Lightfoot and Cook County Board President Toni Preckwinkle.

As the nation’s third-largest city contends with swelling pension fund costs that led Moody’s Investors Service to cut its credit rating to junk in 2015, bondholders are eager to know how the next mayor will approach Chicago’s fiscal problems. Neither of the candidates were backed in the run up to the election by the city’s business community, which threw its support behind third place finisher Bill Daley.

"It was definitely a bit of a surprise," said Dennis Derby, a portfolio manager at Wells Fargo Asset Management. "We will be paying close attention over the next few months to learn more about the candidates and what this means for the credit."

Emanuel, who declined to run for re-election, won plaudits for raising real estate taxes and fees to generate cash for the city’s pensions. He focused on creating growth in Chicago’s downtown neighborhoods by attracting corporate headquarters and other businesses. Both of his potential successors have said the city needs to raise revenue, but neither supports Emanuel’s plan to sell bonds to shore up the retirement plans, according to a local news survey.

The runoff will be held in April.

"The new candidates are going to emphasize the neighborhoods more vis-a-vis downtown and the Loop -- maybe that’s overdue," said Matt Fabian, a partner at Municipal Market Analytics, who said he was surprised Daley wasn’t among the top two finishers. "The economy downtown is very strong, maybe it doesn’t need to be nurtured in the way it has been."

The Financial Challenge

Chicago’s required annual contribution to the city’s four pension funds is set to double to $2.1 billion in 2023 from about $1 billion in 2018, city documents show, because the plans have only about 27 percent of what they need to cover promised benefits. That’s forcing Chicago to pay down the debt and cover new benefits, which led Emanuel to suggest that the city sell as much as $10 billion of bonds to accelerate the process, as well as legalize and tax marijuana and gambling.

Lightfoot’s Views

Lightfoot, who finished first with about 17.5 percent of the vote, according to the latest tally, said that proposals like the legalization of marijuana and the creation of a Chicago casino aren’t going to happen in enough time to make an immediate impact on the city’s finances. “We are going to have to come up with progressive forms of revenue to address the immediate needs now in the budget and for the pension crisis,” she said in a candidate forum.

She doesn’t intend to increase taxes on homeowners, saying the current assessment criteria under-taxes commercial and industrial properties and overburdens residents. "Our goal is to lower property taxes," she said. "Not to maintain them at the high level they are right now. But we can’t really have a serious conversation about property taxes until we fix the broken, rigged and corrupt property-tax assessment system."

Lightfoot is relatively unknown to the financial markets and is "generally considered to be more of a fiscal novice" said Triet Nguyen, a managing partner at Axios Advisors LLC. "Because of her legal and judicial background there might be some uncertainly at the beginning if she does become the mayor about what her stance is and how she tackles the number one problem the city has, which is the pension problem."

Preckwinkle’s Views

Preckwinkle, who was elected to the Cook County board in 2010, supports a tax increase on home sales above $1 million dollars and taxing of recreational marijuana, according to an interview with the Chicago Sun Times. She also supports Governor J.B. Pritzker’s proposal to introduce a graduated income tax. Pritzker advocated for the proposals in his budget address earlier this month. While on the Cook County board, she backed a sales-tax increase to fund the county’s pensions.

"Toni is more of a known quantity for muni bond investors," said Nguyen. "She is fairly well known to muni investors but I think our concern with her is her close alliance with the local unions."

Wells Fargo’s Derby said that Preckwinkle has done a "fairly good job with the county and managing some of their rising expenses" while also managing some of the challenges with a soda tax. She had backed the implementation of a penny-an-ounce tax on sweetened beverages like soda, lemonade or sports drinks that was wildly unpopular with county residents.

Investors Wait

Investors will be closely watching for more specifics about how the candidates will approach Chicago’s finances, since neither appear eager to continue Emanuel’s policies, said Dora Lee, director of research at Belle Haven Investments, which manages $8.5 billion of municipals including Chicago bonds.

"What I’m looking for is a candidate that can build enough political capital to enact the reforms necessary when they get into office," she said early Wednesday. "It’s public finance 101 that they need to fix balancing the budget, addressing the pension problems and finding a financially sustainable tax."

The muni market is looking for either candidate to "establish a track record for fiscal responsibility," said Jason Appleson, a portfolio manager at PT Asset Management. "We need someone who is going to come in and make hard choices and cut expenses."

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