Rating agencies underscore Chicago budget tightrope as council vote looms
Chicago Mayor Lori Lightfoot’s administration sees recent bond rating actions as evidence her budget plan strikes the right balance in managing COVID-19's fiscal wounds.
It’s an argument officials hope can help win over City Council critics as they work to drum up the 26 votes needed to pass the 2021 budget Nov. 24, and it's unclear where the administration might be willing to compromise.
After Lightfoot released her budget, Fitch Ratings affirmed the city’s BBB-minus general obligation rating and Moody’s Investors Service affirmed the city’s speculative-grade Ba1 rating, but both revised their outlooks to negative.
That the ratings held is what the administration says is most important, though the gloomier outlooks underscore her finance team's warnings to city council members that the city must stay on a path to structural balance and preserve its reserves should the pandemic’s fiscal blows deepen.
COVID-19 cases are surging in the city — as well as throughout the state which saw a record number of more than 15,000 cases Friday — prompting Lightfoot on Thursday to issue a stay-at-home advisory and limit gatherings to 10. The state has warned a stay at home order could lay ahead.
“These rating affirmations tell us that the 2021 budget strikes the right balance in addressing the significant challenges created by COVID,” Jennie Huang Bennett, the city's chief financial officer, said in a recent interview. “We are obviously glad for the affirmations but they are not without warnings that things might get worse."
Lightfoot's proposed $4 billion corporate budget wipes out a $1.2 billion gap through a mix of structural measures like a property tax increase and other tax and fee hikes along with efficiencies and non-recurring items like a $1.7 billion debt restructuring and furloughs.
The city attributes 35% of its 2021 budget hole to structural demands and 65% to COVID-19, and says 47% of the measures to tackle the shortfall are structural in nature.
There is “no way to solve a $1.2 billion gap with a 100% structural solutions," Bennett said during an appearance Monday before the Chicago City Club with budget director Susie Park. "The result would be long term damage to certain segments of our economy or flight of our residents. The difficult policy choices in a budget gap of this size become not about which solution but the balance of solutions that are proposed and how they impact the totality of all of our stakeholders.”
City council members have pushed back on the $94 million property tax hike and layoffs, questioning the why the city, instead, isn’t dipping into $900 million of reserves beyond a $30 million planned draw.
Bennett said the city can reach structural balance by 2023, one year past the administration's original target under the budget proposal, but that kicking the can on structural measures would prove all the harder to then balance the 2022 books, when pension payments are slated to jump by $400 million and debt service by $600 million.
“The effectiveness of recurring budget measures is critical to the rating outlook and the city's prospects for returning to structural balance in the post-pandemic period,” Fitch said.
A “widening of structural gap between revenue and expenditures that increases the likelihood that reserves will decline or debt will increase” could drive a downgrade further into junk territory, Moody’s warned.
The rating reports also provide the city with direct evidence that dipping further into reserves to avoid other tougher, structural choices could trigger downgrades.
S&P Global Ratings published a commentary on the budget without acting on its BBB-plus rating and negative outlook, saying “in our view, a sustained deterioration in liquidity or reserves could also negatively pressure the rating.”
Kroll Bond Rating Agency rates Chicago A with a stable outlook.
Fitch’s lead Chicago analyst Michael Rinaldi said there are some benefits to using the debt restructuring instead of draining reserves. Reserves will remain to provide a backup cushion whereas there’s no guarantee that market conditions would remain favorable or the city would enjoy affordable market access should it use reserves now and keep debt restructuring as its backup plan.
Rinaldi believes if the budget is passed without material changes and city revenues don’t plummet to far beyond projections, Fitch's rating would hold in the near term.
Moody’s spokesman David Jacobson offered less certainty.
“Our ratings are not evaluations of individual budgets. We also don’t view any budget until it is final,” he said.
Former Mayor Rahm Emanuel's administration stopped asking Moody’s to rate new deals after the city’s rating tumbled to junk over its pension woes in 2015. The Lightfoot administration has resumed communications.
“We want to make sure that they have as much information as we share with our investors and other rating agencies,” Bennett said but stopped short of saying it will again ask for new ratings. “We will have to see where it goes.”
Scoop and toss
The city will bank $450 million of scoop-and-toss debt relief for 2020 by selling new long-term debt to raise funds to pay off maturing paper.
The city is eyeing issuing short term notes to cover the $450 million to preserve flexibility should a long-stalled federal relief package that compensates cities and states for pandemic-drive tax losses come to fruition.
"One of the first places we would probably pull back on if we could is the debt restructuring. It's not a tool we go to lightly and we've only gone to because we haven't seen federal funding come through,” Bennett said.
The administration has come under some council fire for the scoop-and-toss but not as much as the proposed property tax hike, and Bennett is hoping that restructuring features that limit the long-term damage will make it easier to digest for both the market and council members to digest.
The restructuring is part of a $1.7 billion refinancing of GO and Sales Tax Securitization Corp. debt that will extend the life of the city’s debt portfolio by three years and the bonds being refunded by eight years. The city has about $2 billion of capacity under the STSC second lien without bumping up against debt service coverage ratio limits.
Present value savings of $100 million on the $750 million piece of the deal for more traditional refunding purposes will cover the added debt service costs associated with the $900 million restructuring so that overall the financing is net present value neutral.
“We know that debt restructuring increases the debt burden of the city and we wanted to make sure that overall it was a transaction that we felt was still responsible…that was very much a consideration,” Bennett said.
Former Mayor Richard Daley began using scoop-and-toss to avoid raising the property tax levy to cover growing debt service on new infrastructure borrowing. Emanuel continued the practice until near the end of his two terms in office on the GO credit. Using the STSC credit to refund GOs, the city achieved substantial savings but still pushed out maturities.
As it tries to sell the overall budget plan, the Lightfoot administration is offering up some reminders of its commitment to minority participation and carrot sticks in the form of new capital spending.
The city has issued two large bond deals since Lightfoot took office, a $1.5 billion GO/STSC deal in January and a $1.2 billion airport refunding in September. Minority, women, and veteran owned firms accounted for 53% of the former and 52% of the latter with minority-owned Loop Capital Markets as senior manager on the airport transaction. The city has always met and sometimes exceeded a roughly 30% target on deals under Daley and Emanuel.
Strong consideration is being given to MBE levels on the upcoming restructuring if the council signs off on the deal.
“Significant minority participation is a main goal” for the administration on deals and it is looking at “how we can have minority firms on the top line,” Bennett said.
Some aldermen could also be swayed by the promise of more capital spending in their wards as well as the threat that the city might overlook their requests if they don't vote for the budget package. The administration recently laid out the broad strokes for a $3.7 billion, five-year bond-financed capital plan. Details on the borrowing plans remain sketchy.
"The city is committed to developing a comprehensive, needs-based capital plan that protects our infrastructure, revitalizes communities and creates jobs,” said finance department spokeswoman Kristen Cabanban.