CHICAGO – Spread fallout from Chicago's latest pension and rating setbacks hasn't trickled down to other local governments the way Chicago's plunge to junk did last spring, Markit says in a new report.
The Illinois Supreme Court's March 24 ruling that voided an overhaul of the city's municipal and laborers' pension funds prompted Fitch Ratings to downgrade Chicago a few days later by two notches to BBB-minus, the lowest investment grade level.
Kroll Bond Rating Agency followed a week later lowering its rating to BBB-plus, the same level as Standard & Poor's.
Moody's Investors Service, which dropped the city to junk last May, labeled the court ruling a credit negative but left the city's rating at junk-level Ba1. All assign a negative outlook. The city has $9.8 billion of GOs.
The city's 10-year was trading at a 280 basis point spread to the top-rated Municipal Market Data benchmark before the latest Fitch downgrade and has since reached about 320 basis points. That's after hovering at 200 to 250 basis points late last year and early this year.
"Chicago's municipal bond spread has since widened again, back near levels seen after last year's Moody's downgrade, but interestingly, in divergence to fellow Cook County city spreads," wrote the report's author Neil Mehta, a fixed income analyst at Markit. "As the crisis deepens, it seems Chicago is left more and more isolated."
The city's secondary trading spreads hit a high of about 300 basis points after the Moody's May downgrade. The action followed an Illinois Supreme Court opinion overturning state pension reforms which threw cold water on a path to reforms that could help local governments as well as the state. Most acutely, the court's conclusions had cast doubts on whether Chicago's own pension reforms to its municipal and laborer's fund could withstand a then pending legal challenge.
"Chicago's municipal bond spread widened more than 30% after Moody's' decision, as surprised investors re-evaluated Chicago's credit worthiness," Markit said. "The downgrade also caused contagion in surrounding municipalities, which saw spreads widen in tandem."
The company looked at nine neighboring cities in the Cook County area and averaged spreads at the time, finding a 20% widening of spreads that followed the Moody's downgrade of Chicago to junk.
The spreads of both Chicago and neighboring communities tracked for the report remained volatile through September. Then investor sentiment reversed course, with volatility decreasing and spreads tightening across the board, Markit said.
The narrowing occurred after Chicago approved a record property tax increase last fall to tackle rising police and firefighter pension payments, a move seen as a display of Mayor Rahm Emanuel and the City Council's political willingness to use the city's tax base as part of fiscal fix for $20 billion of unfunded pension liabilities. The city also had mostly resolved a $2.2 billion liquidity crisis triggered by its credit deterioration.
By January of this year, the average spread for the Cook County cities had retracted all the spread underperformance after the Moody's downgrade, while Chicago's percentage change fell from the 40% highs seen in September last year to just 5%, Markit said.
The city reaped the benefit in a primary market sale earlier this year when it was able to trim yield penalties. The spread on its 10-year maturity landed at a 253 basis point spread to MMD. The deal's overall spreads came in about 20 basis points under its summer sale and 40 basis points below a 2015 spring sale.
Markit said that while Chicago's municipal bond spreads are now back near levels seen after last year's Moody's downgrade, fellow Cook County municipal spreads have not been penalized with their spreads holding relatively steady.
The city is planning the sale of up to $1.25 billion of GOs this year, including $600 million of new money and $650 million of refunding and restructuring bonds that would push some principal payment offs in what the city said will mark its final use of scoop-and-toss refunding.
The city's ratings face further erosion.
"The outlook for the city's credit quality cannot be considered stable until such challenges are met in a sustainable fashion," Fitch said in its last report.
"In the near term, the city's credit quality could weaken unless it identifies a funding mechanism to address the unfunded liabilities in the municipal and laborers plans and prevent further destabilization of the city's budget," S&P said.
