Triple dose of bad news for some Chicagoland bond issuers
Chicago’s motor fuel bonds, the city’s park district, and Cook County suffered rating or outlook blows this week due to the strains posed by the COVID-19 pandemic.
S&P Global Ratings on Thursday hit the Chicago Park District with a two-notch downgrade to AA-minus from AA-plus and assigned a negative outlook due to the tougher road it faces addressing a pension fund nearing insolvency given the pandemic’s economic and market fallout.
S&P on Friday moved to negative from stable its outlook on Cook County’s A-plus general obligation bonds and AA-minus on sales tax-backed bonds over risks posed to the county’s balance sheet due to the worsening recession.
Cook’s chief financial officer, Ammar Rizki, said in a statement he was not surprised.
“There is economic uncertainty and financial strain being experienced by businesses and governments across the country during this crisis. From Detroit to Disney, Standard & Poor's has been downgrading ratings and revising outlooks amid the financial fall-out of the coronavirus and we are not immune,” Rizki said.
“Cook County is still receiving investment grade ratings from all major rating agencies despite this public health and economic crisis and we will continue responsibly managing the County's finances and confronting our COVID-19 challenges,” Rizki said.
Fitch Ratings earlier in the week stripped Chicago’s motor fuel tax bonds of their investment-grade rating, downgrading them to BB-plus from BBB-minus, assigning a negative outlook. It’s a move the rating agency had warned could be coming as analysts after a review was triggered by Fitch’s April 16 downgrade of Illinois’ general obligation rating. The state is now rated BBB-minus and the motor fuel bonds are linked off it.
Illinois Gov. J.B. Pritzker recently extended a stay-at-home order that shuttered all non-essential businesses through May, although there are some modifications such garden centers being allowed to open and golf courses permitted some limited operations.
The outlook revisions reflect the “unprecedented pressure” posed by the rapid deterioration in the economy relating to the COVID-19 pandemic and the ensuing recession. "We view Cook County as having more exposure to the economic recession due to a high degree of economic sensitive revenues, high fixed costs, and health enterprise risk,” said S&P analyst Blake Yocom.
S&P Global Economics is forecasting a 5.3% contraction in national gross domestic product this year and a historic annualized decline of almost 35% for the second quarter.
Preservation of the rating depends on the county’s ability to manage sharp declines in revenue and accommodate rising fixed costs as part of its overall debt and other obligations while mitigating health enterprise risk that stems from its hospital system.
“The size of the pension liability, lack of significant funding progress since the adoption of the new revenue stream, and rising fixed costs pressure the rating,” S&P warned.
Cook headed into the pandemic in stronger fiscal shape with a $241 million surplus, ongoing supplemental pension payments, and balanced operations. Health system challenges were already looming as the system grapples with rising uncompensated care costs. The county’s liquidity benefits from cash balances averaged at $423 million as of the end of March.
“Should the county's liquidity and reserves weaken or if it stops making additional pension contributions via the intergovernmental agreement and backslides on its pension funding, or if fixed costs rise faster than expected, the rating could be pressured,” S&P warned. The county made a $350 million supplemental payment last year and this year plans on a $327 million additional contribution. The unfunded actuarial accrued liabilities are $6.8 billion for a funded ratio of 60.9%.
Cook County board president Toni Preckwinkle and her finance team recently laid out the estimated COVID-19 impact. While expenses are expected to be covered by federal relief packages already in place, the county anticipates a $254 million revenue hit to its general and health system general funds.
“In our view, this is likely underestimating the impact. Largest losses include the county sales tax, county use tax, amusement tax, hotel tax, parking, and clerk of court,” S&P said.
The outlook was moved on the sales tax bonds under the rating agency’s priority-lien tax revenue debt criteria, which limits the rating differential between the revenue pledged backing and the rating of the sponsor government. The bonds enjoy strong coverage ratios although they are expected to suffer due to the recession’s impact on sales.
“In our view, the bonds can withstand a drop of about 83% in revenue, down to $142 million annually, and remain above 2.5 times maximum annual debt service coverage,” S&P said. The county had budgeted $849 million from the tax and is now projecting a 9.2% or $78 million hit.
The county has about $414 million of sales tax bonds and $2.8 billion of GOs. S&P a week ago lowered Chicago's outlook to negative from stable. Cook and Chicago are among the governments lobbying for direct aid to offset tax revenue losses from the federal government.
The two-notch S&P downgrade and negative outlook comes ahead of the district’s planned sale of $143 million of new money and refunding debt.
The district already was facing a critical juncture in attempts to stabilize its pension fund after the courts tossed out a funding plan that was aimed at staving off insolvency.
“We think that the severity of the funding shortfall in the pension fund, along with CPD's compromised ability to handle higher pension costs amid a deep recession and just as these costs have become more urgent to forestall pension fund insolvency, mark a turn in the district's credit trajectory that we think is significant enough to warrant the lower rating,” S&P said. The fund carries a $1.3 billion unfunded liability is just 20.8% funded.
S&P expects the state and city-imposed social distancing measures will have a material effect on the district’s operations this year and will lead to a large draw on reserves.
The district is budgeting for an upsized supplemental contribution in fiscal 2020 as part of a four-year ramp to reach actuarial funding and those payments will pressure the budget. Steep market losses would move the plan closer to insolvency. “Were this to occur, CPD would see much higher pension costs in the form of pay-as-you-go benefit payments, which could further challenge its credit trajectory,” S&P said.
The district’s balance otherwise remains in strong fiscal condition with reserves and liquidity in place and if it can manage through the near-term headwinds with a balanced approach it could avoid “further deterioration in credit quality,” S&P said. The district has $894 million of debt.
Ahead of the sale, Kroll Bond Rating Agency on Thursday affirmed the park district's AA rating and Fitch Ratings affirmed on Friday its AA-minus. Both assign a negative outlook.
Fitch cut Chicago’s $96 million of motor fuel TIFIA bonds from a 2013 issue and $82 million of motor fuel refunding bonds from 2013 to BB-plus from BBB-minus.
The bonds enjoy a first lien on all motor fuel taxes distributed to the city by the state, subject to annual appropriation by the state legislature, hence the cap one notch below the state’s rating. Various revenues generated by the city’s downtown Riverwalk are also pledged to the bonds.
“The motor fuel tax bond structure continues to provide solid protection against potential revenue declines in Fitch's scenario analysis and would support a higher rating absent the rating cap,” Fitch said. “The structure's resilience assessment reflects a boost in revenues related to a change in the motor fuel tax rate, in addition to a reduction in leverage following the refunding of the motor fuel tax revenue bonds, series 2008A from proceeds of bonds recently issued by the Chicago Sales Tax Securitization Corporation.” The refunding took place in January.
Fitch expects fuel tax revenue growth to remain stagnant following a significant bump in revenues in 2020 as a result of a doubling of the tax rate effective July 2019. Pledged fuel tax revenues are budgeted at $81.3 million in fiscal 2020.