Chicago's fiscal recovery from coronavirus draws Moody's outlook lift

Chicago’s recovering revenues and a $1.9 billion federal shot in the arm spurred Moody’s Investors Service to lift the city’s outlook to stable.

Moody's (MCO), the only agency to rate Chicago at junk, affirmed its Ba1 rating Monday but reversed its October action that lowered the rating outlook to negative.

“Recovering revenues and a large infusion of federal aid will prevent the city's liquidity position or bonded debt profile from eroding for at least the next two years,” Moody’s said.

Over the last nine months, the federal government adopted the American Rescue Plan Act that will send $1.9 billion to Chicago for coronavirus pandemic relief, property tax collections have held up, and other more economically sensitive taxes are on the rebound after the city and state lifted all COVID-19 capacity restraints on gatherings last month.

Moody’s has rated the city speculative-grade Ba1 since court rulings in 2015 reinforced a state constitutional ban on pension benefit cuts.

Moody’s rating affirmation and outlook lift to stable extends to the city’s motor fuel tax revenue bonds, rated Ba1, and outstanding water and sewer bonds that carry Baa2 and Baa3 ratings depending on their lien.

The motor fuel rating is capped at the city's GO rating due to a lack of legal separation of the pledged revenues from the city's general operations despite strong debt service coverage ratios. It’s also capped at one notch below the state — currently rated Baa2 — because the pledged revenues are subject to state budgetary appropriation. The water and sewer enterprise bonds are linked to the city but not capped.

“As of the close of fiscal 2020, the city's outstanding debt was comprised of $7.1 billion in GO bonds, $181 million in motor fuel tax revenue bonds and $4.4 billion in water and sewer revenue debt,” Moody’s said.

The city and its sister agencies have not asked Moody’s to rate new deals since the agency dropped Chicago to junk.

The city’s junk level rating “balances the city's considerable strengths, including its massive tax base and healthy liquidity, against its extremely sizable unfunded pension liability. The liabilities drive high and growing fixed costs, which are difficult to afford as reflected in the city's persistent budgetary challenges despite its legal ability and demonstrated willingness to raise revenues,” Moody’s said.

The city’s collective net pension liabilities for its four pension funds rose to $32.96 billion from $31.8 billion in 2019, which was up from $30.1 billion in 2018 and $28 billion in 2017 as rising contributions and positive investment returns fail to keep pace with costs and actuarial changes, according to the city's 2020 annual financial report and individual pension fund reports.

The Moody’s action came on the same day Mayor Lori Lightfoot announced a tentative agreement on a long-stalled police contract.

“The costs to finance a potentially sizable police union contract could add to budgetary pressures once settled,” Moody’s said in its analysis, written before the deal was reached.

The estimated $600 million contract with the Fraternal Order of Police union would run eight years and includes a retroactive raise as the union has been without a contract for four years.

About $365 million of the total price tag is to cover retroactive raises and past administrations have borrowed to cover retroactive raises. Lightfoot did not lay out how the city would cover the costs but said during an unrelated news conference that $103 million was put aside in the 2021 budget in anticipation of an eventual pact and that the city had been “tucking money away for this little by little every year.”

“We feel prepared to manage the expense that will be incurred,” Lightfoot said.

The proposal provides an average annual increase of 2.5%. The tentative deal must be ratified by rank-and-file members and the City Council must sign off. The deal also includes accountability reforms for a force that has little handle on the city's violent crime and a history of its own abuses against minority citizens.

Moody’s said it could lift the city back into investment grade territory through a “demonstrated ability to match ongoing revenues with ongoing expenses including the accommodation of statutorily required increases in pension contributions” and/or a “moderation of the city's pension burden arising from robust economic and revenue growth or strong pension asset performance.”

Fitch Ratings rates Chicago BBB-minus, S&P Global Ratings has the city at BBB-plus, and Kroll Bond Rating Agency is at A. All assigned negative outlook in the wake of the pandemic.

S&P lowered its outlook last year citing the pandemic.

"The pandemic did delay the city's timeframe to reach structural balance, moving it to 2023 from 2022, indicating the city's vulnerability to changing economic conditions," S&P_analysts said in a June 30 report affirming the rating and explaining its decision to keep the outlook at negative despite an easing of fiscal pressures.

A return to stable could be achieved "if 2023 operations are structurally balanced, pension ramp-up has been absorbed without a significant spike in carrying charges, and the economy remains vibrant and growing," S&P said.

The outlook change rippled down to the Chicago Park District which is also rated Ba1 due to the close political governance relationship between the city whose mayor appoints its board members and handpicks the superintendent and the shared tax base. The district has $835 million of debt.

“The outlook also reflects our expectation that the district's currently weak contributions will improve without adversely impacting its financial position,” Moody’s said. The district benefits from healthy reserves but its pension costs are on the rise.

State lawmakers in the spring signed off on the district’s pension funding overhaul that moves the system off a path to insolvency to a full funding target in 35 years, with bonding authority. It puts the district’s contributions on a ramp to an actuarially based payment, shifting from a formula based on a multiplier of employee contributions. The statutory multiplier formula is blamed for the city and state’s underfunded pension quagmires.

The district carries ratings in the double-A category from Fitch, S&P, and Kroll.

The park district will ramp up to an actuarially based contribution beginning this year when 25% of the actuarially determined contribution is owed, then half in 2022, and three-quarters in 2023 before full funding is required in 2024. To help keep the fund from sliding backwards during the ramp period the district will deposit an upfront $40 million supplemental contribution. The 35-year clock will start last December 31 to reach the 100% funded target by 2055.

The Park Employees' Annuity and Benefit Fund carried $821 million of unfunded liabilities with just a 29.9% funded ratio for fiscal 2019 and under its current course would exhaust all assets in 2027 without the legislative change.

The new funding schedule removes the imminent threat of insolvency but will take decades to reach healthy funded ratios, so the bill gives the district $250 million in borrowing authority in $75 million annual increments that won’t count against its bonding limits based on its tax collections. The district would use the bonding authority only to cover payouts in the event of a negative cash situation that could occur based on market performance.

The city’s budget season will soon kick into high gear. Over the summer, the city will release its annual financial analysis that lays out the potential 2022 gap and a budget will be released in late summer or early fall.

On Monday, the city announced a series of budget engagement forums will take place in August with the public to discuss 2022 initiatives drafted after earlier public discussions and it will take comments and suggestions on the use of ARPA dollars.

Chicago is still waiting to hear from the U.S. Treasury if it can use its $1.9 billion first to repay $465 million of borrowing on a one-year line taken out in December to help manage the $800 million pandemic-related revenue blow to tax collections last year. Initial Treasury guidance banned using the funds to repay debt but the department accepted feedback until a deadline earlier this month that could lead to changes.

News, commentary and research reports are from third-party sources unaffiliated with Fidelity. Fidelity does not endorse or adopt their content. Fidelity makes no guarantees that information supplied is accurate, complete, or timely, and does not provide any warranties regarding results obtained from their use.