CHICAGO — Chicago lost the triple-A rating on its sales tax-backed debt in a blow that reflects the city's budget and pension strains.
Standard & Poor's late Friday dropped the rating to AA from AAA and warned of further action by putting a negative outlook on the credit. The city has $540 million of outstanding sales tax-backed debt.
The action illustrates Standard & Poor's persistent concern over the city's $20 billion unfunded pension burden despite the City Council's passage last month of a $7.8 billion 2016 budget and record $543 million annual property tax hike to fund skyrocketing police and fire fund contributions.
Standard & Poor's has said the property tax and budget mark notable progress for the city in dealing with its pensions ills, but its commentary concentrated more on the long-term stress posed by meeting the funding demands and the political and legal obstacles facing plans to stabilize the funds.
"The lowered rating reflects our view of the pressures the city's operating budget is facing — particularly from escalating pension contributions and the state's failure to approve changes to the current police and fire pension statutes, which could lead to even higher contributions by the city in the short term if that relief is not granted by the state," said analyst Helen Samuelson.
The city's plan to phase in property tax hikes over the next four years is tied to rising public safety contributions under a revised amortization schedule approved by state lawmakers that eases a 2010 state mandate to move to an actuarially based contribution by 2016. The legislation has not been sent to Gov. Bruce Rauner and its fate is uncertain due to the ongoing state budget impasse. The city will owe another $220 million next year if the schedule is not changed.
"The trend of weakening general obligation credit quality and the overall pressure that places on the city as a whole — including when considering the current burden of sales tax revenue bond debt — have also led to a negative outlook," Samuelson added.
Aside from the direct city risk, the credit's fundamentals remain solid with good debt service coverage ratios. The bonds are secured by revenues from the city's 1.25% home rule sales and use tax, as well as the city's 16% allocation of revenues from the state's 6.25% sales and use tax.
"We note that both of the city's sources of sales tax revenues are capable of covering debt service independently," the rating agency said.
The city continues to receive its share of sales taxes from the state despite its lack of a fiscal 2016 budget but distribution of use taxes has been stalled. The city has collected only $28.5 million of the $69.3 million in use taxes estimated for the year, according to the S & P report.
The sales tax bonds carry mixed ratings. Moody's Investors Service rates them Ba1. It is capped at the same level as the city's general obligation rating, which reflects the absence of legal segregation of pledged revenue from the general operations of the city. Fitch Ratings also caps the bonds at the city's GO level of BBB-plus. The bonds carry a AA-plus rating from Kroll Bond Rating Agency.
The sales tax credit benefits from a first-lien pledge of sales tax revenues that flow monthly to a segregated city fund, with 150% of debt service sent to the trustee to satisfy monthly pro-rated debt service requirements before remaining revenues are forwarded to the city.
Sales tax revenues account for nearly 19% of city operating revenue. The city received $659 million of pledged revenue last year, providing 16.3 times coverage of debt service. Coverage for this year is similar and the city has budgeted collections of $719 million in 2016 with additional issuance planned in the new year for new money and refunding purposes, the rating agency said.
Chicago remarketed $112 million of sales tax-backed bonds in June, paying between 140 basis points to 170 basis points to Municipal Market Data's top-rated benchmark. That was far below the 250 to 300 basis point spread the city paid on its GOs over the summer.
The conversion of floating-rate sales tax bonds as well as $800 million of GO paper allowed the city to get out of swaps, credit lines, and credit facilities on which triggers and default events triggered after Moody's downgraded the city to junk in May. The strain included a sales tax swap that was negatively valued at $32 million.
S&P wrote at the time of the deal that its AAA rating reflected its view "of the city's strong legal provisions and consistently very strong revenue pledge."
