Without touching rating, S&P gives Chicago something to think about
Chicago’s ability to avert a downgrade hinges on honoring its rising pension contribution commitments and continuing to move toward structural budget balance as it navigates the COVID-19 pandemic, S&P Global Ratings said.
Friday's S&P bulletin about the city’s proposed 2021 budget lays out some out landmines for the city to avoid and guideposts to stabilize its BBB-plus rating, which has carried a negative S&P outlook since April.
It doesn’t offer a pronouncement on whether the 47% of structural fixes to a $1.2 billion gap laid out by Mayor Lori Lightfoot in her $4 billion corporate fund proposal are sufficient. The budget doesn't rely on any future federal aid.
“It’s too early” to comment on whether that structural versus one-time mix will avert a downgrade because it will play into a longer-term picture, said S&P analyst Jane Ridley in an interview. “This is the budget they are introducing” and a full review will follow “when the dust settles” on the final package that is approved by the City Council next month.
“The city structured the 2021 budget with a stated goal of achieving structural alignment. In our view, how the city sets itself up in 2020 and 2021 to meet the challenges of 2022 — including the pension ramp-up —is of critical importance to the rating,” S&P wrote.
“If the city's final budget and management's plans to address potential pressures beyond 2021 don't make sufficient progress to return to structural balance, the rating will be pressured further,” the report said. “In our view, a sustained deterioration in liquidity or reserves could also negatively pressure the rating.”
The city is absorbing a $1 billion hike in pension contributions between 2019 and 2022. That’s due to rising contributions as the city committed to making actuarially-based payments in 2020 for the police and fire funds and a looming $300 million spike when an actuarially-based payment hits for the municipal and laborers funds in 2022.
“An expenditure increase of this magnitude would be difficult to tackle at any time, but becomes particularly challenging given current recessionary pressure. The city's ability to absorb the additional pension expenditures and stay on a course to structural balance will be critical to maintaining the rating,” S&P wrote.
Pension appropriations rise to $1.815 billion in 2021 from $1.68 billion and rise by $400 million in 2022 to $2.245 billion. The city is carrying $31.8 billion of net pension liabilities.
Also in 2022, the city will see its debt service shoot up to $800 million from $200 million, because the budget plan relies on a $1.7 billion refinancing and scoop-and-toss debt restructuring with more than $400 million of relief in the current year and $500 million in 2021.
While the borrowing extends debt repayment for near-term savings, the net present value coming from lower interest rates allows the city to avoid adding to the overall cost of the original debt being refinanced, according to Chief Financial Officer Jennie Huang Bennett.
In her Wednesday budget address, Lightfoot stressed that the city is still targeting 2023 for structural balance and Bennett believes the budget plan lays the groundwork with structural fixes from efficiencies, job cuts, and tax increases to address the structural piece of the 2021 gap with a recovery anticipated in 2022. The shortfall stems from a one-time $800 loss of revenue because of the coronavirus and $400 million of anticipated expense growth that is more structural in nature.
The city chose the debt restructuring to address the one-time pandemic revenue blow instead of dipping into more than $900 million in reserves because of the buffer they provide for the city’s ratings and cushion should the city’s recovery lag, Bennett said. S&P doesn’t weigh in on whether reserve use or restructuring is the least damaging option to the rating but makes clear that any big, future draws would be viewed negatively.
“This approach increases the city's fixed costs and can limit flexibility in the future by elevating the debt burden and extending the final maturity,” S&P said. “However, it also allows the city to keep reserves on hand to fill future budget gaps or revenue shortfalls, if needed. Strong and stable reserves are a high point for the credit, and at fiscal year-end 2019 reserves totaled $1.0 billion or 27% of general fund expenditures…a sustained deterioration in liquidity or reserves could also negatively pressure the rating.”