CHICAGO — Chicago's heavy use of non-recurring revenues to balance its budget and sizable unfunded pension liabilities drove Standard & Poor's to drop the city's general obligation rating from the double-A category on Friday.
The agency downgraded the rating applied to $6.8 billion of GOs to A-plus with a stable outlook from AA-minus. The review comes ahead of the city's delayed sale of $804 million of new-money and restructuring GOs.
"The downgrade reflects the city's structural imbalance, its heavy reliance on non-recurring revenues to balance the 2011 budget, including most of what remains from parking meter lease reserves," said analyst John Kenward. "Another negative factor is the low funded ratio of the city's pension funds and the large gap between its payment and the actuarially required contribution."
The city's credit profile "doesn't look like other double-A rated, large America cities," Kenward added.
The city's inability to wean itself from the use of reserves has contributed to a growing structural imbalance as faltering revenue collections fail to keep pace with growing labor and other expenses.
Kenward and Helen Samuelson, also of Standard & Poor's, expressed concern over the size of the city's unfunded pension liabilities — which totaled $14.6 billion in 2009 for a collective funded ratio of just 43 % in the four funds. They specifically cited as worrisome the large disparity of about $700 million between the city's actual annual payment of $450 million and the actuarially required contribution. The city bases its payment on a formula set in state statute, although it is free to increase the payment to meet the ARC.
Chicago's chief financial officer Gene Saffold said in a statement the city believes the downgrade was unfair and didn't recognize the city's maintenance of its permanent $500 million reserve, established in 2005 with proceeds of the $1.8 billion lease of the Skyway toll bridge.
"We disagree with S&P's new rating, and believe it is unwarranted given the progress we have made in reducing expenditures, maintaining substantial reserve levels and working to address our pension liability issues," Saffold said in a statement. "Furthermore, S&P's rating is out of line with the two other rating agencies."
Mayor Richard Daley has proposed that pension-benefit changes recently enacted for new laborer and municipal employees be extended through state legislation to police and firefighters.
Fitch Ratings late last month lowered the city's rating one notch to AA-minus with a stable outlook. The agency in August knocked the credit down to AA from AA-plus and assigned a negative outlook. Moody's Investors Service in August downgraded the GOs one level to Aa3 with a stable outlook and last week affirmed the rating at that level.
Chicago late Tuesday decided to postpone the GO sale's pricing date — originally scheduled for this week — as it appeared buyers would demand a hefty pricing penalty to compensate for the risk they associate with ongoing headlines over both the city and state's fiscal turmoil.
The city was caught off guard with the pricing results on its wastewater and water revenue bond transactions over the last two weeks because both are enterprise systems funded by user rates without exposure to the city's corporate fund or state payments.
A 30-year wastewater taxable Build America Bond — rated from the high single-A to mid-double-A category - carried yields 290 points over comparable Treasuries, a spread far wider than similar deals. The 30-year water revenue BAB — rated in the low to mid-double A category — carried a 6.74% yield, 270 points over the 30-year Treasury last Wednesday.
The city hopes to complete the GO sale, that includesBABs and restructuring bonds, later this month or next after news of the downgrades is digested and headlines critical of the 2011 budget subside. The City Council is expected to vote on the spending plan ater this month. Loop Capital Markets LLC is bookrunner on the transaction.
While the city may find a more opportune time to enter the market, negative headlines are likely to persist over the long term, said one buyside analyst.
"Investors looking at Chicago's credit are likely to see a number of short- and long-term fiscal problems," said Shawn O'Leary, senior research analyst at Nuveen Investments. The headline noise at times will "only get louder" as the city begins to truly address its fiscal pressures, which will likely require union concessions.
Daley's proposed $6.15 billion 2011 budget eliminates a $654 million shortfall by using $120 million from the dwindling reserve accounts set up with proceeds from the city's $1.15 billion lease of its parking meter system last year, $225 million from other reserve accounts, $142 million from restructuring debt, and $38.5 million from surplus tax-increment financing funds. Only $76 million will remain in meter lease reserves after those funds are spent.
The budget limits new spending and includes modest cuts with the elimination of 277 positions. Chicago will maintain a hiring freeze and require furlough days for non-union employees that will trim $96.9 million from the deficit in combination with other personnel cost reductions. The budget includes no new tax, fee, or fine increases and avoids deep spending cuts all of which Daley, who is not seeking re-election next year, believes would damage the economic recovery.