CHICAGO - Moody's Investors Service delivered a stinging blow to Chicago Tuesday, dropping $8.9 billion of general obligation, sales tax, and motor fuel bonds into junk bond territory, citing concerns about the impact of the Illinois Supreme Court's ruling overturning state pension reforms.
The city's two-notch fall to a speculative grade Ba1 damages the city's image, will drive up its borrowing costs when it reoffers floating-rate debt in fixed-rate mode later this month, and triggers a series of headaches relating to bank support on its short-term borrowing program and other credit contracts. The city's GOs were already trading at junk bond levels.
"Based on the Illinois Supreme Court's May 8 overturning of the statute that governs the State of Illinois' pensions, we believe that the city's options for curbing growth in its own unfunded pension liabilities have narrowed considerably," Moody's wrote. The city is saddled with nearly $20 billion of unfunded pension obligations.
"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," analysts wrote. "The magnitude of the budget adjustments that will be required of the city are significant."
Moody's warned of the potential for further deterioration by leaving a negative outlook on the credit. The city has $8 billion of GOs.
"While Chicago's financial crisis is very real and at our doorsteps, today's irresponsible decision by Moody's to downgrade the City's credit by two steps goes far beyond that reality," Mayor Rahm Emanuel said in a statement.
Moody's February downgrade of the city to Baa2 had triggered termination events on four interest-rate swaps; Chicago had renegotiated a lower rating threshold on one those swaps, but Tuesday's downgrade to a speculative grade triggers termination events on that one and another 10. It also triggers a swap termination tied to sales tax bonds from a 2002 issue.
The city previously announced plans to convert all of its floating-rate GOs and the sales tax bonds to a fixed-rate and cover swap termination payments through its short-term borrowing program. The total negative valuation is about $200 million.
The rating agency also hit the city's senior and second lien water bonds, dropping them to Baa1 and Baa2 from A2 and A3, respectively. The agency also downgraded senior and second lien sewer bonds to Baa2 and Baa3 from A3 and Baa1, respectively, affecting $3.8 billion of revenue debt. The outlook remains negative.
As of April 20, the city was carrying about $589 million on its short-term borrowing program that includes lines of credit and a commercial paper program with a total capacity of $900 million. A speculative grade rating triggers an event of default on the city's banking agreements that support the short term program. All of the liquidity contracts expire over the next year. The city has reported ongoing negotiations with liquidity providers to extend the dates.
A default under the city's revolving lines of credit at a speculative grade rating would allow the termination of its credit facilities, requiring the city to immediately pay all outstanding amounts.
The city has 26 liquidity support, letter of credit, and direct purchase facilities on more than $2 billion of floating rate bonds from issues between 2002 and 2014 sold under its GO credit, Midway Airport second lien, O'Hare International Airport third lien, water, wastewater, sale tax credit, and tax-increment financing bonds.
The rating thresholds for events of default on most are triggered at a speculative grade rating, with the exception of four totaling $372 million that are tied to the city's wastewater credit and O'Hare International Airport, which have a threshold below the BBB level.
The downgrade of the second lien triggers events of default on three credit support contracts tied to $332 million of wastewater bonds. The liquidity providers typically under such contract can accelerate repayments. It also triggers swap termination events on at least five swaps tied to those second lien wastewater bonds, with a total negative valuation of about $123 million, according to a city disclosure filing earlier this year. While all liquidity facilities tied to the city’s GO have now been triggered, the city will over the next two months swap its floating-rate GOs to fixed, eliminating the need for support, so those triggers don’t pose as much of a worry to city officials.
A downgrade into junk territory of the Chicago Board of Education's $6 billion of GOs, now rated at Baa3, is likely to follow based on Moody's actions following past city downgrades.
"This action by Moody's is not only premature, but it is irresponsible to play politics with Chicago's financial future by pushing the city to increase taxes on residents without reform," Emanuel said in his statement. "Moody's is out of step with other rating agencies - by as many as six steps."
Standard & Poor's in recent days affirmed the city's A-plus rating and negative outlook and Kroll Bond Rating Agency affirmed its A-minus rating and stable outlook. Fitch Ratings rates the city A-minus with a negative outlook.
Chicago is alone among major cities — with the exception of Detroit which emerged from bankruptcy late last year — in carrying a junk bond rating from Moody's. In recent memory, Pittsburgh was Ba1 in 2004. Other cities have fallen into speculative grade after defaults, including Cleveland in 1978 and New York City in 1975, Moody's said.
