CHICAGO — After years of credit ­stability, Chicago saw Fitch Ratings drop its general obligation rating Thursday to AA from AA-plus due to the weakening fiscal position of a city struggling with rising labor costs, lackluster revenue ­collections, and a burdensome unfunded pension ­liability.

The rating agency assigned a negative outlook to Chicago’s $6.8 billion of GO debt, indicating additional downgrades may be ahead if those problems are not resolved.

The heavy use of one-time reserves to shore up the fiscal 2010 budget along with revenue declines has weakened Chicago’s financial flexibility as it now faces a record $654.7 million deficit for 2011, Fitch said.

The city primarily relied on reserves established with its $1.14 billion parking meter lease and debt restructuring to eliminate a $520 million shortfall in 2010.

Analysts remain concerned about the city’s ability to structurally balance future budgets due to rising employee costs and Mayor Richard Daley’s pledge not to raise property taxes.

“Significant expenditure reductions mostly related to personnel will be required,” Fitch wrote.

Chicago’s failure to adopt long-term fiscal solutions, a weakening of the economy, and the inability to come up with a plan to address its unfunded pension liabilities could lead to another downgrade, Fitch warned.

The rating review comes ahead of the sale later this month of $164 million of tax-exempt GOs and taxable Build America Bonds to fund the Modern Schools Across Chicago Program, which taps tax-increment financing funds to repay debt issued for new school construction projects. Ramirez & Co. and Jackson Securities are the lead managers.

Chicago will sell $70 million of GO tender notes in a separate transaction later this month. It has another new-money and refunding GO issue for up to $900 million planned later this year.

Fitch acted ahead of the release of an expected $6.3 billion 2011 budget in October after reviewing preliminary budget figures announced late last month, the pension report released this spring by a special Daley-appointed commission, labor settlements, and other updated financial information, said Fitch analysts Amy Laskey and Ann Flynn

“The overall profile has continued to weaken and the challenges they face going forward are just increasing,” Laskey said.

Signs of additional strain include the city’s need to issue short-term debt through its commercial paper program to cover about $150 million in raises due as the result of arbitration.

The city is projecting increased costs of $207 million in its corporate fund next year, with the bulk attributed to rising labor expenses. Economically sensitive revenues have failed to rebound by much and are projected to rise just 1.1% next year.

The special commission’s pension report warned that fixing Chicago’s four pension funds might cost at least $660 million more annually by 2012. Without action, the report says all four funds face shortfalls in their ability to meet obligations by 2030 — earlier, if investment returns fall short.

At the close of 2009, Chicago’s four pension funds had a combined unfunded liability of $14.57 billion, representing a collective funded ratio of just 43%.

Other factors that strain the credit include above-average debt levels, unemployment, and foreclosures, as well as a significant degree of exposure to subprime mortgage risk.

The recession has raised unemployment, especially in traditional manufacturing areas. Chicago’s jobless rate in May was 11.2%. 

In the city’s favor is its unquestioned status as the economic hub for Illinois. Chicago benefits from a broad and diverse economy and still holds about $790 million in reserves, though that figure is down from $2 billion held last year.

The city tapped $350 million from its parking-meter lease reserves to help erase a $520 million deficit going into 2010 along with $118 million from a restructuring of debt. It tapped about $500 million in various reserve accounts to balance its 2009 budget.

Daley last year kept his hands off the city’s $500 million permanent reserve, which was set up with proceeds from the $1.8 billion lease of the Chicago ­Skyway toll bridge in 2005. Rating analysts ­upgraded the city after it established the reserve and have said the rainy-day ­money remains central to the current rating ­levels.

Chicago’s GOs are rated Aa2 by Moody’s Investors Service and AA-minus by Standard & Poor’s, both with stable outlooks.

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