CHICAGO – With its pension funding hikes now set in state statute, Chicago won a two-notch upgrade from Kroll Bond Rating Agency Monday that returned one of its battered general obligation ratings to the single-A category.
Kroll raised the rating Monday to A from BBB-plus and assigned a stable outlook, recognizing the city for ramping up contributions “to address severely underfunded pensions” and the rating agency's belief that “addressing these pension obligations long-term will prove to be affordable and sustainable for the city’s wealth base.”
The city’s overhaul is now law after legislative allies inserted the last piece of the changes into the state budget package that cleared in July after lawmakers overrode Gov. Bruce Rauner’s veto. The governor had also previously vetoed the city’s legislation. Kroll also noted that funding pressures have also eased on Chicago Public Schools with more state aid in hand.
Chicago saw its spreads narrow after the state budget’s adoption to between 230 and 250 basis points above the Municipal Market Data’s benchmark, from 300 bp.
MMD strategist Daniel Berger said Monday trades have been limited lately but he estimated current spreads at about 50 bp over Illinois’ 10-year which is at a 178bp spread. IHS Markit's Ed Lee said Chicago's 10-year has traded recently at a 150 bp spread. The spread on a triple-B to the triple-A benchmark is currently at 87 bp, and 52 to the single-A, so Chicago's trading level remains far wider.
Kroll’s action follows recent meetings between Chicago’s officials and the rating agencies for routine annual surveillance on the city’s debt portfolio that includes $9.5 billion of GOs.
All four rating agencies have called the pension funding system overhaul – through a $550 million property tax hike and other new taxes and fees -- a positive step, but the impact on the city’s credit profile has been limited, serving more as a stabilizing factor that staved off more downgrades. Two of the four retirement funds were facing insolvency within a decade.
The other rating agencies remain concerned about how the city will address a payment spike in the coming years after the ramp up to an actuarially determined contribution takes effect and the city's lack of a plan to date.
The city’s net pension liabilities total $35.7 billion and pension payments make a big leap in 2020 and again in 2022. The city is facing a roughly $300 million leap in 2020 for its public safety funds and a $330 million leap in muni and laborers fund payments in 2022. Total payments will rise from $1 billion this year to $2.2 billion in 2022, according to city data.
Moody’s Investors Service rates Chicago at junk-level Ba1 with a negative outlook and its analysis has noted that the overhaul will fail to improve funded ratios for more than a decade, and could suffer setbacks in an economic downturn. The city and its sister agencies no longer ask for Moody’s ratings.
Fitch Ratings rates the city at the lowest investment grade level of BBB-minus. S&P Global Ratings rates the city at BBB-plus. Both shifted their outlooks to stable from negative in the second half of 2016 after the city raised taxes to cover higher contributions.
Kroll had rated Chicago at A-minus but downgraded it in April 2016 after the state’s high court overturned the city’s prior attempt to overhaul pensions with cuts and higher payments.
Chief financial officer Carole Brown has not outlined how the city will cover the future spike in payments but has said everything is in the on the table and reductions in the structural deficit will help the city better manage the growth.
“This upgrade is a reflection of seven years of work to put our pensions on a path to solvency, address legacy debt issues and reduce the structural budget gap," Mayor Rahm Emanuel said in a statement. "While there is still more work to do, today Chicago is on firmer financial footing.”
Kroll has offered the most favorable assessment of the city’s long-term ability to tackle its pension burden. In a special report published last July it concluded the city’s “underlying economy has the ability to absorb and afford the transition needed to fund the city’s growing pension and debt burdens.”
Kroll stressed in its upgrade report that the city has taken a “proactive role…securing necessary legislative reforms by overcoming obstacles presented by the state administration and courts” is a contributing factor, as well as the research in its July report, and the city’s success in winning more funding for CPS as its woes weigh on the city due to deep ties.
“Debt and continuing obligations loom large in the overall rating assignment. If not for debt and pension credit concerns, the city’s general obligation rating would be higher,” Kroll said.