CHICAGO — While the Chicago and Illinois credits both remain tainted by their pension and budget ills, their paths have diverged, Nuveen Asset Management says in a
Chicago has made gains in tackling its fiscal strains while Illinois languishes due to political gridlock, according to Nuveen.
"Illinois' unprecedented budget impasse is ultimately political, and the path to compromise is still unclear. Unlike the state, the city of Chicago is taking steps to address its challenges head on," wrote Nuveen analysts Kristen DeJong and Molly Shellhorn.
Nuveen has participated as a buyer on recent Chicago and Illinois deals.
Illinois has passed just piecemeal portions of its fiscal 2016 and 2017 budgets as Gov. Bruce Rauner, a Republican, remains at loggerheads with the General Assembly's Democratic majorities.
That's left the state with a growing $4 billion budget hole to fill and put its bill backlog on course to close out 2016 at a record $10 billion level.
Chicago, rated junk by one rating agency, has over the last year established new funding plans to bolster its troubled pension systems even though many consider the plans flawed because improvement won't be realized for decades.
The payoff for Chicago's efforts has come in a tightening of its spread penalties and Nuveen believes that it may no longer be at risk for further credit erosion. Illinois' penalties have only widened over the last year as budget gridlock progressed and rating agency hits could continue.
"While the state's credit rating is susceptible to rating downgrades, we think Chicago's identified pension funding proposals should forestall further downward rating pressure," the report said.
Illinois saw its spreads widen to 210 basis points on its June sale from about 180 a year ago while Chicago spreads have narrowed by about 50 basis points. Nuveen considers both issuers to be outliers in the municipal market with Illinois being the lowest rated state and paying the highest credit spreads among states while Chicago pays the highest credit spread of any city except Detroit.
CHICAGO
The Chicago City Council approved a new water/sewer tax on water usage Wednesday to raise funding for the largest of its four funds, which covers general municipal workers. Mayor Rahm Emanuel previously announced plans to use a communications tax hike to rescue the laborers' fund. The funding changes must be approved by the state General Assembly.
The restructurings follow the council's approval last fall of a record $543 million property tax hike to cover higher payments owed to the police and firefighter funds. The city has nearly $34 billion of net pension liabilities.
"Measures taken so far do not fully solve the city's pension funding gap," Nuveen wrote.
Actuarially based contributions won't be established for five to six years and the city will then need to identify a new revenue stream to keep the funds on track toward 90% funded ratios in 40 years.
"Initial analysis indicates a more than $300 million increase in contributions will be required in 2022. If the plan's investment projections are not met over the next several years, this disparity will grow," Nuveen warned about the city's funding schedules for the laborers' and municipal funds.
Still, they mark a big step forward.
"We think the current administration's transparency about the real cost of pensions and efforts to increase annual contributions should be viewed positively," Nuveen said. "The fact that the city is budgeting for a substantial increase in pension funding from a recurring revenue source is a positive development."
While the strides could help the city's long-term credit quality, Nuveen notes the city's rating discrepancies. Moody's Investors Service rates the city junk and the other ratings range from BBB-minus to BBB-plus.
Moody's has been critical of the city's restructurings saying they only serve to ease the growth of unfunded liabilities for decades. Fitch Ratings recently revised the city's outlook upward to stable and S&P Global Ratings has said it would view passage of the water/sewer tax positively.
"This controversial issue involves weighing long-term pension liabilities against the overall economic strength and diversity of the city," Nuveen writes. "Moody's indicated the steps taken thus far are not enough to restore an investment grade rating."
ILLINOIS
Nuveen says it is hopeful Illinois can make fiscal progress after the November general elections when Rauner and lawmakers are expected to return to work on a budget and pension reforms. Strong statutory bondholder protections offer a cushion as the state's red ink mounts.
"By operating without a budget for so long, state leaders have created a structural budget gap too severe to address without significant new revenues or drastic cuts," Nuveen warns.
The stopgap budget agreement approved in June which provides some funding through December is "simply buying time," Nuveen wrote.
Nuveen also worries that pension reforms, if tackled next year, may not make a significant enough dent in the state's $111 billion of unfunded liabilities. The state's five funds have a collective funded ratio of just 42% and payments of nearly $7 billion consume 20% of the state's general fund budget.
"Illinois will continue to have elevated pension costs indefinitely," Nuveen wrote.
Further credit deterioration in the state's Baa2 and BBB-plus ratings looms without results; all three rating agencies assign a negative outlook.
"If no progress is made on a full-year budget by next year, it would not be surprising to see additional rating downgrades by mid-2017," Nuveen writes. "Investors should be prepared for the political process in Illinois to remain volatile over the next six months and expect market moving headlines to continue."
Despite their divergent actions of late, Nuveen said Chicago and Illinois retain some common ground.
"Over the longer term, political willingness to manage budget gaps and keep liabilities in check will be necessary for both entities," the analysts wrote.
