Moody's Downgrades Chicago, IL $8.1B GO to Junk; Outlook Negative

May 12, 2015 5:03 PM EDT

Moody's downgrades Chicago, IL to Ba1, affecting $8.9B of GO, sales, and motor fuel tax debt; outlook negative

Also downgrades senior and second lien water bonds to Baa1 and Baa2 and downgrades senior and second lien sewer bonds to Baa2 and Baa3, affecting $3.8B; outlook negative

New York, May 12, 2015 -- Moody's Investors Service has downgraded to Ba1 from Baa2 the rating on the City of Chicago, IL's $8.1 billion of outstanding general obligation (GO) debt; $542 million of outstanding sales tax revenue debt; and $268 million of outstanding and authorized motor fuel tax revenue debt.

We have also downgraded the following ratings on debt secured by net revenues of Chicago's water and sewer enterprises: to Baa1 from A2 on $38 million of outstanding senior lien water revenue bonds; to Baa2 from A3 on $2.3 billion of outstanding second lien water revenue bonds; to Baa2 from A3 on $35 million of outstanding senior lien sewer revenue bonds; and to Baa3 from Baa1 on $1.5 billion of outstanding second lien sewer revenue bonds.

We have also downgraded to Ba2 from Baa3 the rating on $6 million of outstanding MetraMarket Certificates of Participation (COPs), Series 2010A, and to Ba3 from Ba1 the rating on $3 million of outstanding Fullerton/Milwaukee COPs, Series 2011A.

Finally, we have affirmed the Speculative Grade (SG) short term rating on $112 million of Chicago's outstanding Sales Tax Revenue Refunding Bonds, Series 2002.

The outlook on all long term ratings remains negative.

SUMMARY RATING RATIONALE

The Ba1 rating on Chicago's GO debt incorporates expected growth in the city's highly elevated unfunded pension liabilities. Based on theIllinois Supreme Court's May 8 overturning of the statute that governs the State of Illinois' (A3 negative) pensions, we believe that the city's options for curbing growth in its own unfunded pension liabilities have narrowed considerably. Whether or not the current statutes that govern Chicago's pension plans stand, we expect the costs of servicing Chicago's unfunded liabilities will grow, placing significant strain on the city's financial operations absent commensurate growth in revenue and/or reductions in other expenditures. The magnitude of the budget adjustments that will be required of the city are significant. Furthermore, Chicago's tax base is highly leveraged by the debt and unfunded pension obligations of the city, as well as those of overlapping governments. Balanced against the city's many credit challenges are several attributes, the greatest of which is the city's broad legal authority to tap into its large and diverse tax base for increased revenue.

The Ba1 rating on Chicago's sales tax and motor fuel tax debt reflects the absence of legal segregation of pledged revenue from the general operations of the city. This lack of separation caps the ratings at the city's GO rating, despite sound maximum annual debt service (MADS) coverage provided by pledged revenue.

The Baa1 rating on Chicago's senior lien water revenue bonds reflects the water enterprise's large and diverse service area that extends well beyond city boundaries; the Chicago City Council's unlimited rate setting authority; and sound debt service coverage. These credit attributes are balanced against challenges including an elevated debt ratio and the water system's status as an enterprise of the city, a connection which we believe links the system's credit profile to that of the city's GO. The Baa2 rating on the city's second lien water revenue bonds is based on the credit characteristics of the senior lien water revenue bonds and the subordinate lien pledge of net water system revenue. The Baa2 rating on Chicago's senior lien sewer revenue bonds reflects similar credit characteristics as the senior lien water revenue bonds and also incorporates the sewer system's relatively smaller service area, the boundaries of which are conterminous with those of the city. The Baa3 rating on the city's second lien sewer revenue bonds is based on the credit characteristics of the senior lien sewer revenue bonds and the subordinate pledge of net sewer system revenue.

The Ba2 rating on the MetraMarket COPs, Series 2010A, reflects the tax increment financing (TIF) district's moderate equalized assessed valuations (EAV) and sound debt service coverage provided by pledged revenue. The Ba3 rating on the Fullerton/Milwaukee COPs, Series 2011A, reflects the TIF district's small size, negative trend in incremental EAV growth, and the COPs' subordinate lien on pledged TIF revenue, which is first used to pay debt service on certain series of the city's GO debt. The ratings on both series of COPs incorporate the relationship of the TIFs with the city's GO credit profile.

The SG short term rating on the Sales Tax Revenue Refunding Bonds, Series 2002, is based on the credit fundamentals inherent in the city's Ba1 long term sales tax rating and the conditional liquidity support associated with the bonds.

OUTLOOK

Our negative outlook reflects our expectation that Chicago's credit challenges will continue, both in the near term and in the long term. Immediate credit challenges include potential draws on liquidity associated with rating triggers embedded in the city's letters of credit (LOCs), standby bond purchase agreement (SBPA), lines of credit, direct bank loans, and swaps. The current rating actions give the counterparties of these transactions the option to immediately demand up to $2.2 billion in accelerated principal and accrued interest and associated termination fees. Of this amount, the GO and sales tax revenue rating actions trigger $1.7 billion of potential payments; the second lien water revenue rating action triggers $99 million of potential payments; and the second lien sewer revenue rating action triggers$355 million of potential payments.

The negative outlook also reflects our expectation that Chicago's credit quality will weaken as unfunded liabilities of the Municipal, Laborer, Police, and Fire pension plans grow and exert increased pressure on the city's operating budget. In the near term, Chicago's administration must comply with a 179% contribution increase to its Police and Fire pension plans in 2016.

Developments involving the Municipal and Laborer plans present longer term risks to the city's credit profile. In our opinion, the Illinois Supreme Court's May 8 ruling raises the risk that the statute governing Chicago's Municipal and Laborer pension plans will eventually be overturned. If so, the city's obligation to fund the Municipal and Laborer plans would likely revert to that which existed before the statute took effect in January 2015. Under the prior funding requirements, the city's pension contributions were well below the plans' actuarial requirements. Therefore, if the Municipal and Laborer statute is overturned, and no other adjustments are made to plan revenues and/or expenditures, we believe the plans will continue to extinguish assets to pay annuitants. As the plans move toward insolvency, the city's credit standing will continue to deteriorate, given our view that the state may eventually implement legislation forcing Chicago to pay annuitants directly. Annuitant payments would materially exceed current employer contribution levels. In our view, Chicago's ability and willingness to fund annuitant payments, should they be required of the city, is uncertain.

WHAT COULD MAKE THE RATINGS GO UP (or revise the outlook to stable)

- City or state actions that halt the growth of the city's unfunded pension liabilities

- Revenue growth and/or reductions in other operating expenditures that enable the city to accommodate increased pension costs into annual operating budgets

- Demonstrated legal separation of pledged revenue from the city's general operations (sales tax and motor fuel tax ratings)

WHAT COULD MAKE THE RATINGS GO DOWN

- Determination by a court of law that the current statute governing the city's Municipal and Laborer plans is unconstitutional

- Continued growth in the debt and/or unfunded pension liabilities of the city and/or overlapping governments

- Narrowing of the city's fund balances and liquidity

OBLIGOR PROFILE

The City of Chicago, with a 2010 US Census population of 2.7 million, is the largest city in the State of Illinois and the third most populous city in the US. Chicago's water enterprise serves an estimated population of 5.3 million in northeast Illinois consisting of residents of the city as well as 125 suburban communities. Chicago's sewer enterprise serves 2.7 million city residents.

LEGAL SECURITY

Chicago's GO bonds are secured by a pledge to levy a tax unlimited as to rate and amount to pay debt service. The city's outstanding CP bank bonds are secured by the city's GO full faith and credit pledge but do not benefit from a dedicated levy.

Chicago's sales tax revenue bonds are secured by a senior lien pledge on both receipts of the city's local home rule sales tax revenue and the city's share of state sales tax collections.

Chicago's motor fuel tax revenue bonds are secured by a senior lien pledge on 75% of the city's annual allocation of state motor fuel taxes as well as additional revenues pledged by the city that primarily consist of dock licensing fees collected from tour boats operating on theChicago River.

Chicago's senior lien water revenue bonds are secured by a senior lien on the net revenue of the city's water enterprise. Chicago's second lien water revenue bonds are secured by a second lien on the net revenue of the city's water enterprise. Chicago's senior lien sewer revenue bonds are secured by a senior lien on the net revenue of the city's sewer enterprise. Chicago's second lien sewer revenue bonds are secured by a second lien on the net revenue of the city's sewer enterprise.

The MetraMarket COPs, Series 2010A, and the Fullerton/Milwaukee COPs, Series 2011A, are secured by a pledge of payments made by the city on developers' notes to finance redevelopment in the respective TIF districts. Neither series of COPs is an obligation of the City of Chicago. The city's payments on the respective development notes have been assigned to the trustees by the developers as security on the COPs.



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