CHICAGO Fitch Ratings late Friday socked Chicago’s general obligation rating with a triple-notch downgrade over its mounting pension woes and lack of a solution to date.
Fitch dropped the city’s GO ratings on $8 billion of unlimited tax debt to A-minus from AA-minus. Nearly $500 million of sales tax bonds also sunk three notches to A-minus from AA-minus, and $200 million of commercial paper notes were lowered to BBB-plus from A-plus.
A negative outlook was assigned to the credits. Moody’s Investors Service over the summer hit the city with a similar three-notch downgrade and rates it at the same level at A3 with a negative outlook. Fitch in June put the GO credit on negative watch. Standard & Poor's assigns a negative outlook to the city's A-plus GO rating.
“The downgrade reflects the lack of meaningful solutions to both the near- and long-term burden,” Fitch wrote in the report. “The city has been unsuccessful in its attempts to negotiate a solution with labor unions and lobby the state legislature, which ultimately controls the benefit formula.
The city closed out 2012 with more than $19 billion of unfunded liabilities and its four funds are collectively funded at a just 35.2% ratio, down from 57.3% five years ago. Fitch estimates the funding ratio to be a weaker at 32.9%, assuming a more conservative 7% rate of return. In the short-term, the city faces a $600 spike in 2015 contributions due to state mandated changes to its police and firefighters funds.
Mayor Rahm Emanuel is pressing hard for state legislative action on reforms that combine revenue increases with benefit cuts, but lawmakers are focused on breaking an impasse over state level reforms. Earlier this year, he proposed a reform package agreed to by the leaders of the city’s police sergeants’ union but the rank-and-file rejected it. The city can’t change the benefit structure or employee contributions on its own as they are set in state stature. Emanuel has argued that the city can’t afford the $600 million payment hike that would result in deep cuts and huge property tax increase.
“Fitch believes a pension solution that enhances funding levels while preserving sustainable budgetary balance is necessary to stabilize the credit. Inaction, or affirmative steps to avoid a solution leading up to the looming pension cost increases scheduled for fiscal 2016, will have a negative impact on the rating,” analysts added.
The city’s heavy debt load and the pension burdens of overlapping governments further add to the city’s credit strains. “Pension stress exacerbates the already weak debt profile, which features above-average debt burden and slow payout,” Fitch wrote. “Several overlapping area governments also have underfunded pension systems, which will require some measure of increased funding, presenting a stacked burden on residents and taxpayers.“
Analysts said their concerns over the city’s pension challenges overshadow recent strides in reducing its structural deficit. Other challenges include a slow economic recovery with persistent high unemployment despite revenue growth. On a positive note, Fitch said: “Chicago serves as a regional economic hub for the Midwest region and maintains good prospects for long-term stability if not growth.”
The sales tax bonds are secured by a first lien on the city’s 1.25% home rule sales and use tax and its share of the state-distributed portion of a 6.25% sales and use tax. The CP is secured by the city’s general obligation pledge payable from any legally available funds. Ratings on both credits are capped at the GO level under Fitch criteria. Chicago’s chief financial officer Lois Scott said recently the triple-notch Moody’s downgrade would add $1 million annually to the city’s costs on future GO debt issues for every $100 million borrowed.