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‘Financial hurricane’ hits Chicago’s bond rating

Moody's Investors dropped Chicago's bond rating from Aa3 A3.

Moody's Investors dropped Chicago's bond rating from Aa3 to A3.

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Updated: August 20, 2013 6:29AM



The financial day of reckoning for Chicago that Mayor Rahm Emanuel has been warning of finally came Thursday when a Wall Street rating agency ordered a “triple downgrade” of Chicago’s all-important bond rating.

Moody’s Investors dropped the city’s bond rating from Aa3 to A3, citing Chicago’s “very large and growing” pension liabilities, high-fixed costs, “unrelenting public safety demands” and “significant” debt load.

“You don’t usually see a triple-downgrade unless there is a catastrophic event, such as a natural disaster or terrorist attack,” said Civic Federation President Laurence Msall.

“This is a financial hurricane event for Chicago. ... The city’s borrowing costs will rise dramatically and their ability to use creative financing is going to be limited because of the costs associated with having such a low rating.”

The bond rating at the Chicago Public Schools has dropped repeatedly since Emanuel took office, but Thursday’s triple-drop was the first impacting the city’s bond rating.

“The current administration has made efforts to reduce costs and achieve operational efficiencies, but the magnitude of the city’s pension obligations has precluded any meaningful financial improvements,” Moody’s wrote

Emanuel responded by essentially saying, “I told you so.”

“This confirms what I have been saying for more than a year. Without comprehensive pension relief from Springfield, municipalities such as Chicago will continue to receive negative reviews from rating agencies,” he said in a statement.

“I have used every tool available to tackle and reform government, strengthen our financial position, and invest in our City’s future.  But the pension crisis that is nearing our doorstep puts all of those investments at risk.  I urge our leaders to come together, find common ground, and pass pension relief that will give taxpayers, retirees, residents, and rating agencies confidence in our City’s finances and our City’s future.”

In a telephone interview later Thursday, members of Moody’s public finance team called the triple-drop in Chicago’s bond rating the “most significant” for a major U.S. city in recent memory.

“We adopted a series of adjustments in April to the way we reported pension data and incorporated it. This review is the first under the updated approach and one of the drivers for the multi-notch action,” said Moody’s analyst Tom Aaron.

“We identified the city of Chicago as an outlier due to the size of the liability and available resources.”

Pressed on what actions Emanuel could take on his own to reverse the precipitous ratings decline, Moody’s managing director Jack Dorer said, “We’re not here to tell anybody what to do.”

But Rachel Cortez, Moody’s vice president of public finance, said, “What the city is able to control is raising revenue. Chicago is a home-rule entity. They have very, very broad — nearly unlimited ability to raise property and sales taxes. Whether that would be politically possible [is another matter]. But legally, the mayor and the City Council can raise the revenue.”

She added, “On the expenditure side, because the city has not been contributing at actuarily determined annual contribution levels over at least the past decade, the liabilities have grown to the point where any reduction in costs would have to require the state legislature to decrease benefits for current participants. The liability has just grown enormous.”

At A3, Chicago’s general obligation debt remains investment grade. But the lower rating impacts $8.2 billion in debt and means Chicago taxpayers will pay higher interest rates to borrow money.

Even more ominous is Moody’s “negative outlook” for Chicago’s future ratings because of what the agency calls “formidable legal and political barriers” to pension reform that can only be approved by the General Assembly.

In its report, Moody’s noted that Chicago closed the books on 2012 with $231 million in general fund reserves and $625 million in “leased asset reserves” generated by former Mayor Richard M. Daley’s decision to privatize the Chicago Skyway and Chicago parking meters.

Had the city fully funded its $1.5 billion “actuarially required contribution” to the four city employee pension funds in 2012 alone, “these two reserves would have been entirely depleted,” Moody’s said.

Moody’s noted that in 2015 the city is required by state law to make a $600 million contribution to stabilize police and fire pension funds and start them on the road to 90 percent funding. Exacerbating the problem is the “prior and current administration’s unwillingness to avail itself of its full taxing authority to stave off burgeoning pension liabilities,” the Moody’s report states.

Fixed costs, which Moody’s identified as pension contributions and debt service — may soon swallow more than 50 percent of Chicago’s operating budget.

“To be sure, it would be extremely politically difficult to double property taxes, which is our estimate of what would be required to fully fund” the pension plans, Moody’s wrote.

“[But] whether the restriction on raising property taxes is legal, political or practical, any barriers to increasing operating revenues to fund pensions are credit negatives for bond holders.”

The rating agency noted that “any meaningful reduction in pension costs would need to apply to existing plan participants,” but the Illinois Constitution states that pension benefits for existing employees “shall not be diminished or impaired.”

The report states, “Neither the formidable legal barriers to reducing pensions costs nor the political reluctance to raising taxes augers well for the health of the city’s four pension plans.”

Last year, Emanuel blindsided and infuriated union leaders whose collaboration he had promised to seek to solve the pension crisis.

Instead of negotiating first with union leaders in Chicago, he went to Springfield to lower the boom. The following day, he sent a letter to city employees to soften the blow of the bitter pill he’s asking them to swallow: a 10-year freeze in cost-of-living increases for retirees; a five-year increase in the retirement age; a 5 percent increase in employee contributions and a two-tiered pension system for new and old employees.

Labor leaders accused the mayor of pitting hardworking employees against taxpayers by portraying a 150 percent increase in property taxes as the only alternative to employee concessions.

In the end, Chicago’s pension crisis was put off along with state’s $83 billion pension problem as lawmakers continued to grapple with rival plans championed by House Speaker Michael Madigan and Senate President John Cullerton, both Chicago Democrats.

That continued stalemate has prompted Gov. Pat Quinn to withhold the salaries of state lawmakers until the fiscal time bomb is diffused.

Earlier this year, Emanuel took the bold step of phasing out Chicago’s 55 percent subsidy for retiree health care by January 2017 while continuing that coverage for the oldest retirees.

The plan will free taxpayers from a $108.7-million-a-year burden. Some 30,000 retired city employees will be forced to switch to Obamacare.

“That is very commendable work with a significant impact, but the rating agencies are saying that pales in compare to the risk that the state of Illinois is not going to address pension reform and the city won’t be able to continue operating these funds,” Msall said.

“If they don’t [solve the crisis], the rating agencies will further downgrade Chicago and, eventually, we’ll lose the ability to borrow money necessary to operate the city. The city needs to borrow money not just for capital needs, but to make up for lags in revenue collection and the general operation of city government.”



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