Chicago's spreads have widened ahead of a refinancing next week and a new money deal next month, suggesting the market may be pricing in a downgrade before any of the rating agencies have taken that step, analysts said.
"Chicago can't do anything about the
A Chicago general obligation bond maturing in January 2036 with a 5.25% coupon carried an evaluated yield of 5.583% as of Thursday's close, representing a spread of approximately 155 basis points to the AAA benchmark, according to data from Municipal Market Analytics. The spread was 148 basis points on Sept. 17 and 124 basis points on Sept. 16, MMA said.
The upside for Chicago is that the city has a near-term opportunity to show fiscal discipline through its 2027 budget process, which is getting underway, said Lisa Washburn, chief credit officer and managing director at Municipal Market Analytics.
If the city can continue its supplemental pension payments and find more recurring revenues, and if it makes budget decisions that aren't based on optimistic assumptions or refinancing, that could help its credit trajectory, she said.
New recurring revenues "are a lot more stable than going to the refinancing ATM," Washburn said.
"There's no question Chicago spreads have widened a bit as of late," said Justin Marlowe, research professor at the University of Chicago's Harris School of Public Policy and director of the Center for Municipal Finance.
But it's not fair to characterize it "as 'they're blowing out'" or "that we're headed back to the dark days (of 2016-17). It's nowhere near that," he said.
The city plans to refinance $500 million of Sales Tax Securitization Corp. bonds on Tuesday and is targeting an Oct. 20 pricing for $650 million of GOs, according to a finance department spokesperson.
Chicago's GOs are rated BBB-plus by KBRA, BBB-plus by Fitch Ratings and BBB by S&P Global Ratings, with negative outlooks, and Baa3 with a stable outlook by Moody's Ratings. Junk status would be falling below the BBB-minus or Baa3 rating.
The STSC bonds are rated A-plus with a negative outlook by S&P, AAA with a negative outlook by Fitch and AAA with a stable outlook by KBRA. The second lien STSC bonds are rated A-plus with a negative outlook by S&P, AA-minus with a stable outlook by Fitch and AA-plus with a stable outlook by KBRA.
Marlowe said the market may well be pricing in a downgrade.
"If you were a credit analyst at some place on the buyside, and you look at what the ratings agencies have telegraphed vis-a-vis the city's credit — they've said things like, 'You can't continue to rely on big (tax increment financing) sweeps, you can't continue to rely on refinancings; you've got to figure out a better way to interact financially with (Chicago Public Schools) — and if you don't do those things, you're going to see a downgrade,'" Marlowe said.
"All of those things are still happening, and so I think if you're an analyst, you might say, yeah, we're going to price this in before the ratings agencies make the formal announcement," he said.
In a
"We now trade at spreads that are higher than the average sub-investment-grade bond in the Bloomberg high-yield municipal index," Loren wrote.
Marlowe said there are extenuating circumstances, including that "you could probably attribute at least half of the widening of Chicago spreads to just triple-B spreads in general widening."
Another dynamic is "massive shifts in the technical factors, particularly in that triple-B space," he said. Supply liquidity considerations have been important, Marlowe said, and "certainly you hear about a lot more issuance generally, and given how much more issuance has been happening, particularly in the more creditworthy parts of the market, that has put upward pressure on yields in the AA and thereabouts categories."
But Marlowe agreed with Loren that if Chicago's yields become prohibitively high, the refinancings Chicago is planning to lean on, including for the fiscal 2027 budget, will "eventually become untenable."
"Chicago has been utilizing the STSC for years now to refinance GO debt that is higher yielding by arbitraging the rating that it has on the STSC, and the savings that they get have (served) to get cash to balance the budget," said MMA's Washburn.
The refinancing gambit "doesn't go on indefinitely in the current rate environment," Washburn said.
That tactic has also been a concern because the city often shifts payments on the GO debt further out, she said.
"The debt structure changes to provide overall relief," Washburn said. "I've always worried that it's finite. Once you've refinanced all of your GO debt, or you've run out of capacity in your STSC vehicle, then that source of cash that comes into the budget will dry up."
Loren has disagreed with the city on interest rate trajectories and what those should mean for Chicago's debt management strategy.
"My market view for the last several years, going back to 2022, has been: we're in a structurally higher rate environment and that's going to be tough for cities," he said.
"If liquidity dries up and everyone freaks out, it's just going to be a very tough market to price into, and you're going to see pricing that I think (Chicago) wasn't expecting," he added.
The dynamics Loren highlighted raise concerns about Chicago's ability to borrow, said Danny Vesecky, senior policy and research associate at the Civic Federation, a Chicago-based fiscal watchdog.
That means less savings from refinancings and higher costs from higher interest payments or a need to reduce the amount borrowed, which in turn means less capital to spend on projects.
The Civic Federation has warned about fiscal decisions, like
"We saw the rollout of a bond last year for judgments and settlements," Vesecky noted. "If the city tries to do anything like that in its future budget, or borrowing for operational costs … it makes future refinancings more difficult. And that's something that's been put on the table relatively recently by the mayor to handle the current budget gap that's opening up for this fiscal year, as well as next year's."
While Chicago can't control the broader market picture, it can raise its profile relative to other issuers, "and raise its perception in the eyes of investors and the credit rating agencies in terms of its reliability," Vesecky said.
"That's always a long-term project," he said, pointing to the city's legacy burdens, like underfunded pensions, large structural budget deficits in recent years, and "the political instability" that has marked the last few budget cycles.
"This year's budget process will be a big (turning) point for investors and for credit rating agencies to see, is Chicago going to continue down the path that it has been on?" Vesecky said.
