Moody's, citing pension crisis, downgrades Chicago's debt to junk status

Posted: 05/12/2015, 04:17pm | Fran Spielman - Reuters

Moody’s Investor’s Service on Tuesday dropped Chicago’s bond rating two more notches — to junk status — turning up the heat on Mayor Rahm Emanuel to raise property taxes and on the Illinois General Assembly to approve a Chicago casino.

“It is irresponsible to play politics with Chicago’s financial future by pushing the city to increase taxes on residents without [pension] reform,” Emanuel was quoted as saying in an emailed statement.

The decision to drop the bond rating that determines city borrowing costs — from Baa2 to Ba1 with a negative outlook — comes just days after the state Supreme Court unanimously overturned state pension reforms and placed Emanuel’s plan to save two of four city employee pension funds in similar jeopardy.

The rating applies to $8.1 billion in general-obligation debt, $542 million in outstanding sales tax revenue debt and $268 million in outstanding and authorized motor fuel tax revenue.

“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 unfunded pension liabilities have narrowed considerably,” Moody’s wrote.

“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.”

Moody’s noted that the “magnitude of the budget adjustments” that will be required to solve the combined, $30 billion pension crisis at the city and public schools are “significant.” Chicago’s tax base is “highly leveraged by the debt and unfunded pension obligations” of the city and overlapping governments, the rating agency said.

“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,” Moody’s wrote.

Emanuel responded to the alarming drop by blaming the messenger.

The mayor acknowledged that Chicago’s financial crisis is “very real and at our doorsteps.” But he called the Moody’s double-drop “irresponsible,” “far beyond reality” and “out of step with other rating agencies — by as many as six steps.”

“Their decision was driven solely by the overturning of a state pension bill that did not include Chicago’s pension reform, yet they did not downgrade the State of Illinois,” the mayor was quoted as saying.

“They refuse to acknowledge Chicago’s growing economy, progress we have made on our legacy financial liabilities, balancing four budgets without raising property taxes while adding to our reserves, securing pension reforms for two of the City’s four funds . . . that were previously in danger, and the progress we are now making with our partners in labor at the other two city funds.”

Emanuel accused Moody’s of jumping the gun in an attempt to hold the new City Council’s feet to the fire.

“I am committed to focus on both reform and revenue to address Chicago’s fiscal crisis, and we will continue our work in Springfield and with our partners in labor to ensure we will always meet our obligations, protect the retirements of our work force, continue to deliver vital city services, while protecting our taxpayers,” he was quoted as saying.

Earlier this month, Emanuel unveiled a plan to insulate the city’s bond rating from another drop tied to the state pension ruling by moving away from risky financial practices that former Mayor Richard M. Daley used to “mask” the true cost of city government.

It called for: terminating risky swaps; converting general-obligation debt from variable to fixed interest rates; phasing out the “scoop-and-toss” practice of paying short-term obligations with long-term debt and weaning the city away from the dangerous habit of borrowing to bankroll costly legal settlements.

Now, ending those practices could be more costly.

The plan was already going to add $105 million to the city’s operating shortfall. There was also a $230 million penalty to get out from under swaps that was to be folded into the refinancing to avoid putting added pressure on the city budget.

Budget Director Alex Holt said Tuesday the city plans to forge ahead with that plan, even though “swaps that overlay variable rate debt” could be called in immediately as a result of the double-downgrade.

“If they do, there will be termination payments we’ll need to make. But we were going to take out $200 million in variable rate debt anyway over the course of this year,” Holt said.

As for the city’s ability to borrow to fund capital projects, Holt said, “We think the capital markets will continue to be available to us. We think investors still have confidence in the city.”

Moody’s described the penalties in much more dire terms.

“Immediate credit challenges include potential draws on liquidity associated with rating triggers embedded in the city’s letters of credit, stand-by bond purchase agreement, lines of credit, direct bank loans and swaps,” Moody’s wrote.

“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.”

Moody’s decision to turn up the heat for new revenue comes just days before the new City Council is sworn in.

“It’s unfortunate timing. We know there’s a task in front of us. This just makes it a little more — I don’t want to say urgent. But it complicates it a little more than it needs to. It has a chilling effect on anything we’d like to do in the financial markets,” said Ald. Pat O’Connor (40th), the mayor’s City Council floor leader.

With the Municipal Employees and Laborers pension reforms in jeopardy and a state-mandated, $550 million payment due in December to shore up police and fire pension funds, O’Connor was asked whether the City Council would act quickly to raise property taxes.

“What is the amount that will get the rating agencies off your back and not cripple the recovering housing market? No amount of property tax increase gets you out of the problem,” O’Connor said.

“If people roll up their sleeves and try to work out an agreement, we could at least have a road map to this in a short period of time. That would be a much better solution than us looking to pass some symbolic property tax hike. We need to sit with the unions and with our counterparts in Springfield so we can all be working on the same problem at the same time. I don’t think any of it has to wait. It just has to be coordinated, and it has to be now.”

Civic Federation President Laurence Msall called the double downgrade “terrible, but not unforeseeable news” for the city and “every government” across the state.

“This will make short-term borrowing much more expensive and will necessitate the termination of all city swaps associated with general-obligation bonds, which currently have a negative value of more than $200 million,” Msall said in a statement.

“When these deals were made, it was almost inconceivable that the City of Chicago would ever be downgraded to speculative grade credit. Moody’s decision is a direct result of Friday’s Illinois Supreme Court ruling to overturn the 2013 Illinois pension reform law, but it remains to be seen how the courts will decide on the city’s pension reform legislation which was negotiated with the city’s unions and is based on a different legal argument.”