Fresh Chicago rating reports out as city readies $1.2 billion refinancing
With the ink still fresh on a 2020 budget, Chicago Mayor Lori Lightfoot cleared another hurdle with a round of general obligation rating affirmations as the finance team preps a $1.2 billion refinancing.
The city is selling $176 million of GO refunding bonds and $1 billion of junior lien Sales Tax Securitization Corp. bonds as soon as the week of Dec. 9. The latter is tentatively being offered in three series for $760 million due in 2039, $193 million of forward delivery bonds due in 2034, and $71 million of taxables due in 2024.
The combined $1.2 billion of borrowing will refinance $1.3 billion of callable general obligation and motor fuel tax revenue bonds. About $210 million of the savings are being taken upfront, one linchpin in Lightfoot’s elimination of an $800 million gap in the $11.65 billion budget approved by the council Tuesday.
“Today’s ratings by S&P, Fitch and Kroll confirm from independent financial stakeholders that the city of Chicago is moving in the right direction by addressing our urgent financial challenges,” Lighftoot said in a statement Tuesday.
Fitch Ratings affirmed the city’s BBB-minus rating, Kroll Bond Rating Agency affirmed its A rating, and S&P Global Ratings affirmed its BBB-plus. All three assign a stable outlook.
Moody’s Investors Service rates the city one notch below investment grade. It has not been asked to rate new city bond sales for a few years, and the new administration has not reversed that policy. The city has about $8 billion of GO debt.
The first STSC rating on the new lien that is subordinate to $2.6 billion of senior lien bonds sold by the city over the last two years under a $3 billion authorization is also out. S&P gave the new lien the same AA-minus and stable outlook rating as the senior lien.
Lightfoot’s chief financial officer, Jennie Huang Bennett, had targeted preservation of the city’s GO status as a goal of the budget plan and the fix for the 2020 was crafted with that in mind with more structural measures over one-time maneuvers for a 60/40 % mix and no unplanned draws on reserves. The city also is adhering to the pension payment schedule that calls for a nearly $300 million spike in 2020 to bring contributions to the police and firefighters funds to an actuarial level.
The rating affirmations give the city some breathing room as clouds loom large over the next two years as the city has assured analysts it can achieve structural balance by 2022. That’s the same year that another roughly $300 million pension contribution spike hits to reach actuarial funding for the municipal and laborers funds.
“Chicago's ongoing ability within the next year to demonstrate a credible path to structural balance, including fully funding its pension ramp by 2022, will be critical to our rating analysis,” S&P analyst Jane Ridley wrote. “Achieving anything less than full structural balance by fiscal 2022, when the full actuarially based statutory payment ramp up will occur, will be a backslide and would have an negative impact on the rating.”
The pressure will grow if the administration doesn’t win changes in the 2020 session from state lawmakers to the real estate property sale tax or to the tax structure for a proposed casino to attract an operator and financier. Lighftoot struck out on both in the fall veto session.
The city is counting on $100 million a year from the real estate tax and $200 million once a casino is up and running. Lightfoot has warned that a property tax hike probably would be needed if the revenues don’t come to fruition.
The city has laid out alternatives to the rating agencies should the real estate or casino revisions fail or are delayed. “The city has drawn up a number of contingency plans which could be implemented if either of these is not achieved. These include additional debt refundings, and as a last resort, a new property tax,” Fitch wrote.
While the city is making headway on pension funding, it’s slow going under the plan to reach a 90% funded ratio by 2055. “Upward rating momentum is unlikely until annual contributions are sufficient to accomplish this stabilization, but failure to show progress according to the city's plan could put negative pressure on the rating,” Fitch said.
The city has $30 billion of net pension liabilities and the system is just 23% funded.
“The stable outlook incorporates Fitch's expectation that the city will continue to make progress toward structural budgetary balance, including progress toward actuarially-sustainable pension contributions, and maintain reserves commensurate with the rating throughout the economic cycle. A reversal of this trend could lead to negative rating action,” Fitch said.
S&P said the adopted budget leaves the city with a 7% structural imbalance, but it’s giving the city time to reach its target.
“While we do not consider the use of one-time budget-balancing actions favorably, given the large gap, we consider some use of one-time measures a reasonable, and not uncommon approach. In this situation, we note in particular that the city is using these one-time measures to buy time to implement structural solutions to fully align its operations by fiscal 2022,” Ridley said.
KBRA posted its rating but a full report was not yet available.
S&P was first out of the box with a rating on the new junior lien, holding the new credit steady at the senior level of AA-minus. The rating agency, however, originally rated the senior lien AA before changes to its priority lien criteria last year capped the rating at four levels above the credit of the obligor, in this case the city of Chicago.
The rating reflects the application of the agency’s Priority Lien criteria, which factors in both the strength and stability of the pledged revenues, as well as the general credit quality of the municipality where taxes are distributed and/or collected.
“Although the debt service coverage levels and additional bonds test are different on the first and second-lien bonds, the two lien ratings are on parity given the four notch limitation above the obligor credit in our priority-lien criteria,” S&P said.
The outlook reflects the expectation that Chicago's budgetary pressures won't significantly worsen over the two-year outlook horizon, given the city's recent measures to address its pension liabilities and achieve structural balance by 2022, S&P said. “The outlook additionally reflects the state's near-term fiscal stability, which, in our view, strengthens the adequacy of its resources to reliably cover its priority obligations.”
Though the city has asked Kroll and Fitch Ratings to rate the STSC bonds, their analysis was not yet published. They rate the senior lien AAA.
Using fiscal 2018 sales tax revenues of $687.4 million all-in maximum annual debt service, or MADS, is $295.4 million, with coverage of all first- and second-lien debt at 2.33 times. Coverage of the first-lien bonds is higher at 4.03 times. To issue more second-lien bonds, the ABT requires 1.75 times coverage of the new MADS amount using sales tax collections for the most recently completed fiscal year. Under the master indenture, the ABT for additional senior-lien debt is 4 times.
Pledged sales taxes flow directly to the trustee from the state and residual amounts not needed for debt service are freed up for city use. There is no debt service reserve fund requirement for either the first- or second-lien bonds.
The STSC is separate, bankruptcy-remote special purpose entity from the city insulating it from a potential Chicago bankruptcy if the state were to add a Chapter 9 statute, it enjoys statutory lien status, and the rating agencies consider the asset transfer a true sale. The 2017 state legislation allowing for home rule units to set up such entities to leverage revenues like sales taxes that flow through the state includes state non-impairment language.