CHICAGO – Illinois’ new borrowing program for home rule local governments could ensure higher ratings for Chicago and other qualified issuers if properly structured, Fitch Ratings said.
“If properly applied by a home rule entity, the structure could result in ratings higher than and without regard to the issuer default rating,” Fitch wrote in the report “Illinois Legislation Gives Chicago New Financing Tool,” published Wednesday.
Fitch is the first rating agency to weigh in with an assessment of the “assignment of receipts” program created in the state budget package that became law earlier this month after lawmakers overrode Gov. Bruce Rauner’s veto.
The law allows the state’s 200 home rule municipalities to dedicate – or assign -- tax revenues they receive from the state to a special limited use entity. That entity in turn would leverage those revenues in a way that bypasses the local government’s own coffers and shields them from the threat of being dragged into a bankruptcy proceeding.
The structure and features such as a statutory lien were designed to win higher ratings and in turn lower borrowing costs. Chicago’s chief financial officer, Carole Brown, enlisted the help of local bond counsel firms to craft the language for the program as a means to sidestep the city’s own battered general obligation ratings that range from junk to BBB-plus, and also impact some of its revenue-backed deals.
The pledged revenues would then become property of the issuing entity rather than the transferring unit. Fitch would look for the bond documents prepared for a proposed financing to make clear that the assignment is irrevocable and that the transferring unit gives up its right, title and interest in or to the transferred receipts needed to repay the issuing entity's obligations, read the review.
“Since operating risk resides with the transferring unit rather than the issuing entity, the issuing entity debt would be rated without consideration of operating risk, as represented by the IDR,” Fitch wrote.
The program surfaced earlier this year in a Senate budget package and was later revised to include statutory lien language that would apply to any borrowing and the assigned receipts.
Fitch said the lien language provides “additional protection to bondholders by eliminating the incentive to challenge the ownership of the revenues in a bankruptcy of the transferring unit, as the bankruptcy code provides that bondholders would have a right to the continuation of the lien in a bankruptcy.”
Fitch also considers the law’s non-impairment language a positive. The state pledges not to alter the power of the state officers or offices to transfer receipts to the issuing entity and pledges not to change the basis on which the pledged revenues are derived.
Revenue streams that municipalities could tap include their share of personal property replacement taxes, gambling, sales tax, local government distributive fund revenue, and motor fuel tax revenues. Because those assigned to the special entity would no longer belong to the local government, the question over whether they qualify as special revenues under the bankruptcy code would not apply.
Fitch said the Illinois program resembles those of several authorities in New York, all of which are rated AAA.
The new structure in Illinois raises concerns for some market participants.
Such structures are typically created in an environment where stressed credits are looking to lower borrowing cost, but those efforts are undertaken without regard for the value of existing bonds which could be harmed by the diversion.
“You are carving out a piece of the pie. The pie isn’t getting any bigger,” said Joseph Rosenblum, director of municipal credit research at AllianceBernstein. For existing holders the revenue stream is being diluted, he said, so right away, the older debt is weaker credit-wise.
If a government’s credit grows more stressed, existing holders could see further loss of liquidity and value as the alternative structure may be viewed as more sound.
Municipal Market Analytics said lowering borrowing costs through refinancing with the new structure is a positive for Chicago, but the city must show discipline.
“If borrowing costs are reduced as the state and city likely expect, there could be an incentive for the city to increase its debt load,” MMA wrote in its weekly outlook.
“If the city failed to show fiscal restraint and increased its borrowings, any credit positive impact of the refinancings would quickly be reversed," the firm wrote. “Investors holding callable, high coupon Chicago bonds should anticipate the heightened risk of seeing their bonds redeemed,”
Even with the addition of the statutory lien, MMA remains concerned over the “durability” of the structure in legal proceedings until tested, given lessons learned in Detroit and Puerto Rico’s bankruptcy filings.
The statutory lien on revenues “to benefit bondholders isn’t likely to sit well with the city’s unions that, based on Illinois court decisions, reasonably believe that their pensions are untouchable,” MMA warned. “Elevating bondholder claims, albeit only on specified revenues, is almost certain to be litigated.”
Chicago’s finance team said Wednesday it is “still reviewing this financing tool, but our intent is to maximize the revenue that will get the best market response.”