CHICAGO — Chicago's motor fuel tax credit took a hit from Moody's Investors Service this week as the agency moved to bring the credit in line with Illinois' rating due to the appropriation risk tied to tax revenues that repay the bonds.

Moody's downgraded the rating three notches to A3 from Aa3, one notch below the state's A2 rating, and assigned a negative outlook. The action impacts $181 million of outstanding debt.

The motor fuel bonds are secured by a senior lien pledge of a portion of the city's share of state motor fuel tax revenues which are subject to annual appropriation. The state General Assembly has authority to adjust tax rates and the appropriation of revenues that are sent to local governments.

"The state's ability to alter pledged revenues presents the risk of non-appropriation, and the rating is therefore notched from the state's general obligation rating," Moody's wrote. "The state's ongoing budget pressures enhance the risk that motor fuel tax revenues could be diverted for other state purposes."

The city’s GOs are rated Aa3 with a negative outlook. Moody’s said the timing of the downgrade was driven by the heightened appropriation risk due to the state’s struggles. Chicago has not issued motor fuel tax bonds since 2008.

The latest review comes as the city is preparing later this year to issue up to $275 million of new money and refunding motor fuel bonds. The City Council approved the transaction at a meeting Wednesday.

Fitch Ratings also notches the rating one mark below the state's GO credit and last month put the motor fuel bonds' A-minus rating on negative watch to reflect similar action in January on the state's A bond rating.

Aside from the state's fiscal woes, the credit is challenged by a slow amortization schedule and annual declines in pledged revenues over the last seven years due to falling fuel consumption and a drop in population. Both are factors in the allocation formula.

Even with the declines, debt service coverage remained solid at 3.2 times last year and 3.4 times in 2011 and the city ordinances governing the debt establishes a monthly set aside of pledged revenues with the trustee, who receives funds directly from the state. Other strengths include the requirement of two times coverage before additional debt is issued and all the debt is in a fixed-rate structure.

Rating agencies have not rated the new deal which is still in the planning stages. Loop Capital Markets LLC is the senior manager and Cabrera Capital Markets LLC and BMO Capital Markets are co-senior managers. The final sizing depends on the outcome of the city's application for $96.5 million in loan assistance for its Wacker Drive reconstruction project through the federal government's Transportation Infrastructure Finance Innovation Act program.

The state's fiscal woes have negatively impacted the ratings of some local governments, schools, and public universities that rely on a state appropriation or direct aid and most paper sold by Illinois-based issuers faces some interest rate penalty simply because of the Illinois name — even those that are top-rated and face little exposure to the state's finance.

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