“While Chicago and CPS are legally separate entities with distinct credit profiles, they share the same tax base and have some overlapping governance,” Moody’s Investors Service writes in a new report.

CHICAGO – Chicago's fiscal position and Chicago Public Schools' deep distress are the subject of two special reports published Thursday by Moody's Investors Service.

The reports offer market participants a deep look into the city's and CPS' overall fiscal condition and near and longer-term pressures.

They were published two days after Chicago released a December letter in which Mayor Rahm Emanuel attacks the rating agency for keeping the city's rating at the junk level of Ba1 with a negative outlook and requests that Moody's withdraw all of its GO and revenue bond ratings. The city, which has not asked Moody's to rate new issues for several years, said Moody's declined.

Chicago has a $1.16 billion GO issue slated to sell Wednesday or Thursday.

On the surface, the reports appear to tackle head on the city's criticisms of the rating agency's inclusion of new factors in its credit profile in more recent reports -- such as CPS' fiscal distress.

Moody's spokesman David Jacobson said there's no link in the timing.

"Both of these reports have been in development since we affirmed the city's rating last November," Jacobson said.

Moody's offered praise for the city's efforts to bolster pension funding over the last year, calling it a "favorable" departure from the past and acknowledged the city's expanding economy and healthy liquidity, even though it's not enough to move the rating upward.

"While Chicago's recent tax increases will provide revenue to significantly increase pension funding, the city's unfunded pension liabilities exceed seven times its revenue and are projected to grow for at least 15 more years," said Moody's analyst Matt Butler.

CPS' strains are more acute and its liquidity crisis is worsening amid the continued state budget impasse, Moody's said.

The district, which issues bonds through the Chicago Board of Education, is rated B3 with a negative outlook.

"While Chicago and CPS are legally separate entities with distinct credit profiles, they share the same tax base and have some overlapping governance," which means the school district's intensifying fiscal distress weighs on the city's credit profile, Moody's adds.

"We believe that the most likely scenario for CPS is that the district will levy for debt service on GO alternate revenue bonds in order to free up state aid for operations," Moody's wrote. CPS currently abates the tax levy pledged to debt repayment and uses an alternate source like state aid.

The worst-case scenario would be for CPS to pursue state authorization for bankruptcy, but analysts acknowledge that's unlikely given Emanuel's opposition to such a move which is not currently permitted under state law, Moody's said.

 

CHICAGO

 

While recent pension funding increases prompted three rating agencies to stabilize their outlooks on the city's bonds, Moody's said the city has yet to "fix" it pension problem.

Moody's remains concerned about the 15-year timeframe the revised plans take before funded ratios begin to improve and chip away at the $33.8 billion net pension liability tab and that those improvements are based on an optimistic 7.5% investment return.

Another big jump in city contributions looms in 2021 because current tax increases only cover the increased payments owed to the four funds during a phasing in of actuarially based contributions. New revenue will be needed once the ARC payments begin.

Tax fatigue among city residents -- hit with a series of taxes for the city, district, and Cook County – could hurt the city's ability to meet those payment demands to keep the funds on pace to a 90% funded level in 2055.

"There is a limit on Chicago's ability to raise taxes on its citizens and businesses, because each increase tempers the appetite for further tax hikes that could be needed," Moody's wrote. The city has earmarked $800 million in new and increased taxes for pensions.

While dramatically up, the 2017 payment of $1 billion is still less than half of Moody's $2.3 billion estimate of what's needed for the plans just to halt the unfunded growth and will remain about $800 million short once ARC payments begin in 2021.

 

CPS

 

"CPS' deteriorating credit profile reflects years of budget imbalance which have completely drained operating reserves, leaving the district with minimal protection against further budget pressures," said Moody's analyst Naomi Richman.

CPS is projecting a general operating fund balance of negative $88 million at the close its fiscal 2017, compared to a positive $1.1 billion in 2012. The district will have just $100,000 left in its debt service stabilization fund balance at the end of June compared to $255 million in fiscal 2012.

While CPS has turned increasingly to expensive short-term borrowing in the form of tax anticipation notes, it's closing in on a state cap that limit TAN borrowing to 85% of annual property taxes levied for district operations. The district levied $2.3 billion last year for operations. If TAN borrowing continues to rise at the current clip it would hit the cap in 2018 or 2019.

The district issued $1.1 billion of TANs in fiscal 2016, up from $700 million in fiscal 2015, and its authorized amount totals $1.55 billion this year.

The district has tapped $950 million of the current authorization and will issue the remaining $600 million this month. CPS's monthly cash flow projections show a deficit cash position at the end of every month through the end of fiscal 2017 with a deficit net cash position of $919 million expected and just $31 million in cash June 30. The TANs are supposed to be repaid in August.

The budget also hinges on several unknowns. Rauner vetoed $215 million in teachers' payment help amid the ongoing state budget impasse and lack of state pension reform legislation and its fate is unclear.

"The state's pronounced fiscal pressures and lack of political consensus do not bode well for CPS's hopes of a state rescue," Moody's wrote.

The district also needs the teachers fund to agree to credit towards its $720 million June 2017 payment $250 million in future property tax collections. State lawmakers approved the pension levy last year but it won't have the funds in hand by June 30. The district is also seeking a credit for the $215 million.

If neither of these budget assumptions holds, and CPS makes its full required pension payment by June 30, 2017, the district's deficit net cash position on that date could hit $1.4 billion, Moody's warned.

Although it was not asked to rate the district's recent $730 million CIT issue, analysts said they view the new structure "to be at least as strong as, if not modestly stronger than, CPS's GO bonds."

"This view reflects the strength of the CIT tax levy and structural features of the CIT bonds, balanced by the uncertain value of these features in a potential Chapter 9 bankruptcy," Moody's said.

CPS legal advisors say the revenues would likely continue to flow in bankruptcy and protect bondholders from impairment. The CIT bonds are secured solely by the pledged tax revenue, can go only to pay for capital projects or repay CIT bonds, and flow directly to a trustee managed lockbox.

Moody's said it worries over the lack of case law and uncertainty a Chapter 9 would raise given attempts to impair revenue bonds that were considered insulated from Detroit's Chapter 9 filing.

State law would have to change to allow the school district to file for bankruptcy.

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