Moody's Investors Service said it has downgraded the city of Chicago's general obligation and sales tax ratings to A3 from Aa3; water and sewer senior lien revenue ratings to A1 from Aa2; and water and sewer second lien revenue ratings to A2 from Aa3.
Chicago has $7.7 billion of GO debt, $566 million of sales tax debt, $2.0 billion of water revenue debt, and $1.3 billion of sewer revenue debt outstanding. The outlook on all ratings is negative.
The ratings on Chicago's GO and sales tax debt were placed on review for downgrade in April due to the city's large adjusted net pension liability (ANPL) relative to its rating category.
The downgrade of the GO rating reflects Chicago's very large and growing pension liabilities and accelerating budget pressures associated with those liabilities. The city's budgetary flexibility is already burdened by high fixed costs, including unrelenting public safety demands and significant debt service payments.
The current administration has made efforts to reduce costs and achieve operational efficiencies, but the magnitude of the city's pension obligations has precluded any meaningful financial improvements. These credit challenges are balanced against key credit strengths that support the A3 rating, particularly Chicago's long-standing role as the center of one of the most diverse economies in the nation and its broad legal authority to generate revenues from a large property tax base and a larger sales tax base.
The negative outlook is based on the dramatic spike in annual pension payments scheduled to take effect in the 2015 budget year (payable in 2016) under state law, which will place material strain on the city's operating budget. The outlook incorporates the likelihood of continued growth in unfunded liabilities in the city's four pension plans given currently suppressed contributions from the city.
The outlook also reflects the state of Illinois' (A3/negative) constitutional protection of pension benefits. Given this framework, in order for the city to realize any significant alleviation in pension costs, the Illinois General Assembly would need to enact pension reform legislation that ultimately withstands inevitable litigation.
The downgrade on the sales tax rating reflects the lack of legal separation between pledged sales tax revenues and the city's general operations; this structure effectively caps the sales tax rating at the city's GO rating. The A3 rating on the sales tax debt also reflects very ample debt service coverage and a strong additional bonds test (ABT) that should prevent overleveraging of pledged revenues.
The downgrade on the water and sewer revenue ratings reflects the interconnectedness between the two enterprises and the city's general operations. Both systems are ultimately governed by the mayor and city council. Ratings on the senior and second lien debt remain above those of the city's GO and sales tax debt due to the minimal impact of pension costs on the utilities' financial operations. The rating differential between the senior and second lien revenue debt reflects the senior lien debt's stronger debt service coverage.