The recession driven by the COVID-19 pandemic will pressure Chicago’s rating, S&P Global Ratings warns in a report explaining its decision to move the city’s outlook to negative from stable.
"The outlook revision reflects the unprecedented credit pressure facing the city from the rapid deterioration in the U.S. economy caused by health and safety measures relating to the COVID-19 pandemic and the related recession," S&P credit analyst Jane Ridley wrote.
S&P affirmed the city’s BBB-plus rating, three rungs above speculative grade, in a Friday report.
The city’s ample liquidity of at least $2 billion in available cash and a $470 million federal aid distribution girds its ability to manage near-term efforts to expand some services and programs and ease fines and fees to aid the public and business. S&P says the city, as Mayor Lori Lightfoot has asserted, also can weather moderate economic pressures in its $11.65 billion all-funds budget that includes a $4.5 billion corporate fund.
But S&P Global Economics is forecasting a deeper national economic toll and longer road to recovery, which would take a more damaging toll on city tax revenues.
“The sharp economic decline and expected revenue deterioration, along with pressures related to the pandemic, will make the city's path to structural balance more challenging,” S&P warned. “Ramping up to full actuarial pension funding will likely be more difficult as well, because equity market declines could necessitate escalating contributions.”
The city has $30 billion of net pension liabilities and the system is just 23% funded. S&P considers it an “absolute essentiality” that the city honor funding commitments.
The city’s budget this year incorporated a $270 million increase in police and firefighter pension contributions as those two funds ramp up to an actuarial-based payment plan. In 2022, the city is facing another big jump of about $300 million as the ramp up to actuarial contributions for its municipal and laborers funds takes effect.
The city’s general obligation bonds carry a BBB-minus rating from Fitch Ratings, a junk rating of Ba1 from Moody’s Investors Service, and an A from Kroll Bond Rating Agency. They assign stable outlooks.
The city accounts for 18,679 of the state’s 45,883 confirmed COVID-19 cases as of Monday and 773 of the 1,983 deaths. Illinois is operating under stay-at-home order that closed non-essential businesses through the end of May, according to the Chicago Department of Health.
The outlook change prompted similar action on the city’s Sales Tax Securitization Corp. bonds. S&P affirmed the bonds’ AA-minus rating but moved the outlook to negative as S&P’s priority lien criteria takes into consideration the strength and stability of the pledged revenues as well as the general credit quality of the municipality or obligor.
“While our outlook horizon extends for up to two years, we believe the risks facing the city over the next year will be key to future credit direction,” S&P said. The city has $7 billion of GO debt and has issued about $3.7 billion of senior and junior lien STSC bonds.
The city’s bonds have suffered a notable widening of secondary market trading spreads over the last month in tandem with movement on the state’s secondary trading. Chicago’s bonds are “thinly traded and the last time we saw them they were at plus 350 bps” to the Municipal Market’s AAA benchmark, said MMD-Refinitiv market strategist Daniel Berger. The city’s 10-year in a January sale landed at a 105 basis point spread.
Chicago spreads earlier this month ranged from plus 310 to plus 370 basis points, said Edward Lee, strategist at IHS Markit.
Lightfoot has acknowledged the uncertainties that loom but has presented them as more manageable than the picture S&P painted. Lightfoot stresses that no one tax revenue represents more than 13% of the city’s corporate fund and exposure to economically sensitive revenues to support operations is limited to under 25%. Property taxes, which are considered less economically sensitive, go to fund pensions and debt service.
But that exposure from taxes on sales, transactions, transportation, recreation and income taxes is sufficient at 35% to weigh on the balance sheet, S&P said. Risk abounds, also, in efforts at the state legislative level to raise new revenue.
“Two of the city's new proposed revenues remain in the mix — the Real Estate Transfer Tax and a tax on expanded casino gambling — but even if they are implemented, the recession could cause collections to be lower than was anticipated pre-recession,” S&P warned.
The city needs state legislative approval to revise the tax structure on a proposed casino that is estimated to eventually produce $200 million in new revenue for pensions and to change the tax on property sales to generate $100 million annually.
The city did not provide a comment in response to S&P’s outlook change.
“It puts investors on notice that something might change but it’s also giving the city the opportunity to respond with a plan,” said Michael Belsky, executive director of the Center for Municipal Finance at the University of Chicago’s Harris School of Public Policy.
While the city was struggling with pre-existing fiscal weaknesses from rising pension and debt costs that the Lightfoot administration inherited when it took office last year, its economic trajectory was on the upswing from a robust economy. That economy has now been shut down making the city’s case for federal aid a strong one, Belsky said.
Laying out the potential tax hit could help the city’s case as governments across the nation lobby for direct aid for tax losses, Belsky said.
Cuts at a time when demand is up for services make managing through the economic toll more difficult and make one-time fiscal maneuvers like dipping into fund balances or delaying capital spending more palatable. “But it’s important to have a plan” that restores any balances used, Belsky said.
S&P lays out some potential triggers as the city tries to keep chief financial officer Jennie Huang Bennett’s goal of structuring balancing the city’s books by 2022 on track. A downgrade could occur if progress toward budget balance and full actuarial funding of pensions is impeded by the recession or there’s sustained deterioration in liquidity or reserves.
The city received $470 million from Illinois’ roughly $2 billion share of local government aid in the Coronavirus Aid, Relief, and Economic Security Act signed March 27 and is eligible for funds from other programs to cover most costs created by the pandemic. The city has incurred about $150 million of costs.
Lightfoot’s administration has not yet released revised revenue projections for the 2020 budget and is lobbying for direct aid to compensate for lost revenue in the next federal relief package.
The fate and timing of such aid is unclear given the political wrangling in recent days. Senate Majority Leader Mitch McConnell suggested last week he favored allowing states to file bankruptcy instead of providing federal relief, and President Trump has issued contradictory statements and tweets about his position.
Lightfoot has vowed not to dip into the city’s $550 million long term reserve from the lease of the Chicago Skyway or to push off pension contributions and has no plans so far to lay off or furlough employees.
“We want to make sure we come out of this experience as strong as possible. What we don’t want to do is something that shrinks government” or undercuts “the city’s long-term financial position,” Lightfoot said earlier this month.
The city’s ratings had been stable heading into 2020 despite the use of $323 million in one-time revenues to help close an $800 million gap, as rating agencies acknowledged Lightfoot’s efforts to move toward structural balance by 2022.
The coronavirus has added the concern that the triple-B-minus state government may undermine local budgets.
“In our view, projections for a very large budget gap at the state level means that the city cannot rely on the state for any additional support, and also increases the chance for a shift in revenue-sharing payments to local units of government,” S&P said. State sales taxes and the city’s local share of state income taxes each account for 6.3% of city operating revenues and could be reduced by the state.
On pension funding, the city has little room for error given the poor funded ratios and that leaves it all the more exposed to volatile market results that could drive up actuarial contributions. “It is possible that even if the city takes all the right steps to align expenditures with revenue, effects from COVID-19 and the recession could still result in fund performance that sets funding levels further back,” S&P warned.
The STSC bonds could face a downgrade based on either a lowering of the city’s GO rating or from a notable deterioration in coverage provided by the sales taxes pledged to the bonds, S&P said. The STSC can withstand a drop of about 45% in revenues, down to $393 million annually, and remain above 1.5x all-in coverage.
