CHICAGO — Chicago’s heavy use of reserves and other non-recurring revenues to balance its proposed 2011 budget triggered a downgrade Thursday of its general obligation rating to AA-minus by Fitch Ratings.
The downgrade, with a stable outlook, is the latest in a series of negative rating actions for city. Fitch moved in August to lower its rating to AA with a negative outlook from AA-plus. Moody’s Investors Service in August downgraded its $6.8 billion of GOs one level to Aa3 with a stable outlook. Those actions followed Chicago’s release of a preliminary budget with a $654 million shortfall. Standard & Poor’s rates the city’s GOs AA-minus with a stable outlook.
Earlier this month, retiring Mayor Richard Daley announced a $6.15 billion 2011 budget that relies heavily on non-recurring revenues to avoid new tax, fee, and fine increase or deep cuts. The City Council will vote on the plan next month.
In conjunction with the downgrade Thursday, Fitch lowered $331.5 million of outstanding sales tax bonds to AA-minus from AA-plus. Coverage levels remain solid but the rating is linked to the city’s GO credit.
The GO downgrade comes ahead of Chicago’s upcoming sale of $804 million of tax-exempt and non-Build America Bond taxable new-money, refunding, and restructuring debt, and regular BABs. Neither Moody’s nor Standard & Poor’s have released updated reviews. The city plans to take retail orders Nov. 8 and hold an institutional pricing the next day.
Loop Capital Markets LLC is senior manager and Wells Fargo Securities is co-senior manager. Gardner, Underwood & Bacon LLC is financial adviser.
“The downgrade reflects the city’s weakened financial flexibility as evidenced by the continued use of long-term financial reserves and other non-recurring revenues to offset severe revenue declines and increased spending pressures,” Fitch analysts Ann Flynn and Amy Laskey wrote in the report.
Chicago’s chief financial officer Gene Saffold pointed out in a statement that the city’s GO ratings remain strong in the low, double-A category. “As always, the city will look to price the new GO bonds in the most favorable borrowing rate environment, and will continue to monitor the market to take advantage of the most opportune time to access the lowest possible rates,” he said.
The city’s fiscal strains and challenges continue to mount. Revenue collections are lackluster while employee costs are rising and city leaders remain reluctant to raise property taxes.
Chicago’s unfunded pension liabilities of $14.6 billion are rising due to an ongoing failure to make payments at an actuarially determined funding level. Long-term reserve levels, once strong, are dwindling, and city debt levels are above average while amortization is slow.
“Fitch believes meaningful and timely measures to address the large and rapidly increasing liability, while practically and politically difficult, will be important to maintaining the current rating level,” analysts wrote of the city’s pension struggles.
Daley has proposed that pension benefit changes recently enacted for new laborer and municipal employees be extended through state legislation to police and firefighters, but that move would make just a small future dent in Chicago’s liabilities. The city’s four funds have a collective funded ratio of just 43%.
Chicago’s strengths remain its broad revenue streams and its broad and diverse economic base. The city has moved to trim spending through layoffs, a hiring freeze, furlough days, and other cost-cutting initiatives.
The non-recurring revenues proposed in the 2011 budget include $120 million from the dwindling reserve accounts set up with proceeds from the city’s $1.15 billion lease of its parking meter system last year; $225 from other reserve accounts; $142 million from restructuring debt; and $38.5 million from surplus tax-increment financing funds. Little is left of the city’s meter lease reserves, but its $500 million reserve from the 2005 lease of the Skyway toll bridge remains intact.
Another $68.2 million was trimmed through the use of “strategic financing options” that includes the diversion of the 35% interest rate subsidy the city will collect next year on wastewater and water revenue BABs being sold this month and next.
“Given the continued use of reserves and other one-time revenue sources to balance operations, Fitch believes rising costs for public safety and the continued slow economic recovery will severely limit the city’s ability to achieve structural balance without working structural solutions,” analysts wrote.
The city’s corporate fund in the budget totals $3.26 billion, up $80.5 million over 2010. Personnel costs account for 80% of that fund.
Chicago has increasingly turned to reserves and other one-shots since 2009 to help balance its budgets amid growing gaps. Officials closed a $520 million 2010 shortfall with $118 million in debt restructuring, which pushed out bond maturities, and with $350 million from reserves.
The city’s housing market remains stressed, with the rate of foreclosures continuing to rise through 2010 and housing starts down. Exposure to the subprime market is high and well above the national average. The city’s unemployment rate stood at 10.8% in August, above the state and national averages of 9.9% and 9.5%, respectively.
Chicago carries a $787 million unfunded other post-employment benefits liability. It paid $88 million in 2009 towards the liability that is funded on a pay-as-you-go basis. Its overall costs are limited by a settlement with its retired employees to pay a portion of their health care benefits. That settlement expires June 30, 2013.
Daley recently announced he would not seek another four-year term in the February election.
