Investor, rating judgments on the line as Chicago plots fixes to coronavirus-induced budget wounds
Chicago’s ratings and spread penalties are at heightened risk as Mayor Lori Lightfoot attempts to close a combined $2 billion pandemic-driven budget gap for 2020 and 2021 absent a federal hand, Municipal Market Analytics warns.
The value of bonds issued by Chicago’s sister agencies, like Chicago Public Schools and the Chicago Transit Authority, could also face fallout, MMA believes.
“MMA now has a more negative outlook for city of Chicago bonds," Matt Fabian, a partner at MMA, writes in the firm’s weekly outlook distributed Wednesday.. "We continue to view Chicago’s default risk as minimal, but the city’s potential for rating downgrades and sustained budget and credit pressure has risen sharply.”
“This speaks poorly for city bond spreads through year end and beyond, and ostensible city, CPS, or CTA buyers likely have time to wait for downgrades and/or incremental cheapening before adding to existing positions,” he continued.
The city’s GO bonds are rated BBB-minus by Fitch Ratings, A by Kroll Bond Rating Agency, junk-level Ba1 by Moody’s Investors Service, and BBB-plus by Standard & Poor's Global Ratings. S&P assigns a negative outlook; the others assign a stable outlook. Chicago’s spread volatility is tied to market stability and its own headlines. It saw a sharp narrowing in its January sale to a 105 bp spread to the MMD AAA benchmark, but during the March and April market outflow turmoil, spreads jumped above 300 bps. The bonds, which don’t trade frequently, have fluctuated since, with a small 2029 bond trading this week at slightly over 300 bps, said MMD-Refinitiv senior market strategist Daniel Berger.
Lightfoot and her finance team — Chief Financial Officer Jennie Huang Bennett and Budget Director Susie Park — last week laid out grim projections raising by $100 million to $800 million the current year tax blow due to the COVID-19 pandemic’s economic impact. The city has made headway in trimming $550 million of the 2020 gap but is now staring at an estimated $1.2 billion hole for the 2021 budget due to a combination of continued tax losses and rising pension and other costs, many of which were expected.
Bennett and Park laid out some options, including additional debt refinancing, to generate at least $100 million in upfront savings. The city’s January refinancing generated $100 million more than expected in savings that will go to close the 2020 gap. Other options being explored include management efficiencies, furloughs, job cuts and layoffs although the latter is a next-to-last resort, just ahead of a property tax hike.
“The reality is stark, our options in this fiscal crisis are limited — all of which require some hard and yes, painful choices,” Lightfoot has warned.
Lightfoot and her finance team are pushing hard for federal relief to compensate the city for lost revenues, but if it’s not forthcoming before the budget’s release next month, a plan will be laid out to tackle the shortfall through a mix of measures.
Absent new federal relief, the city faces a treacherous road and there are downsides to even structural solutions like raising new revenue, MMA warns. “The city’s October budget will depend, in large part, on whether or not Congress provides additional aid before then (unlikely), and whether or not the state can be relied upon to provide meaningful help (also unlikely ahead of the November ballot),” Fabian writes.
The state is facing billions in lost tax revenue and its 2021 budget for the fiscal year that began July 1 relies on up to $5 billion of borrowing through the Federal Reserve’s short-term lending program in the absence of a quick infusion of federal relief.
Gov. J.B. Pritzker is banking on voters approving a constitutional amendment lifting the requirement for a flat income tax rate so the state can raise rates on top earners to generate at least $3 billion more in annual revenue, which could ease potential cuts in local income tax sharing levels.
That “raises the likelihood of Chicago turning to more dangerous budget gimmicks, like pension obligation bonds, creating aggressive projections for intergovernmental aid, or being compelled to sharply raise taxes and cut spending,” Fabian said. "The last would normally be a preferred, more structurally based outcome, but in 2020 they will exacerbate economic pain from the pandemic and hinder the region’s rebound once the pandemic subsides.”
The city is exploring using pension obligation bonds, but any deal would be accompanied by reforms to make it more amenable to rating agencies and investors, Bennett said last week.
“MMA expects a large POB offering would not only debilitate long-term credit quality but could also catalyze near-term rating downgrades (starting as soon as this year) by at least three of the four rating agencies," he warned. "And because this is Chicago, even less offensive budget solutions pose larger-than-typical risks to investor perception/ratings.”
The city’s pension contribution rises to $1.81 billion in 2021 from $1.68 billion to cover rising contributions for all four of the city’s pension funds. The city is carrying $31.8 billion of net pension liabilities, and funded ratios for the funds are at 18% for firefighters, 21% for police, 24% for municipal, and 43% for laborers.
The 2020 shortfall in the $11.61 billion all-funds budget with a $4.4 billion general fund is due to tax and fee losses. In 2021, the city had been planning for $421.3 million in increased expenses, but it’s also now projecting a $783.2 million revenue beating due to the pandemic’s lingering impact. Lightfoot last year faced a more than $800 million deficit and $500 million was erased with structural changes, while the remainder was closed with one-time sources.