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Rating Action:

Moody's downgrades Chicago, IL to Baa1 from A3, affecting $8.3 billion of GO and sales tax debt

Global Credit Research - 04 Mar 2014

Also downgrades water and sewer senior lien revenue bonds to A2 from A1 and second lien revenue bonds to A3 from A2, affecting $3.3 billion of debt; outlook negative for all ratings

New York, March 04, 2014 --

Moody's Rating

Issue: General Obligation Bonds, Project Series 2014A; Rating: Baa1; Sale Amount: $109,000,000; Expected Sale Date: 3/6/2014; Rating Description: General Obligation

Issue: General Obligation Bonds, Refunding Series 2014B; Rating: Baa1; Sale Amount: $108,000,000; Expected Sale Date: 3/6/2014; Rating Description: General Obligation

Issue: General Obligation Bonds, Taxable Project Series 2014C; Rating: Baa1; Sale Amount: $44,000,000; Expected Sale Date: 3/6/2014; Rating Description: General Obligation

Issue: General Obligation Bonds, Taxable Refunding Series 2014D; Rating: Baa1; Sale Amount: $127,000,000; Expected Sale Date: 3/6/2014; Rating Description: General Obligation

Opinion

Moody's Investors Service has downgraded the City of Chicago's (IL) general obligation (GO) and sales tax ratings to Baa1 from A3; water and sewer senior lien revenue ratings to A2 from A1; and water and sewer second lien revenue ratings to A3 from A2. The outlook on all ratings is negative.

Concurrently, Moody's has assigned a Baa1 rating to the following new issuances: $109 million GO Bonds, Project Series 2014A, which will fund various capital projects; $108 million GO Bonds, Refunding Series 2014B, which will refund certain outstanding debt maturities for expected interest savings; $44 million GO Bonds, Taxable Project Series 2014C, which will fund the payment of legal judgments; and $127 million GO Bonds, Taxable Refunding Series 2014D, which will restructure certain outstanding debt maturities for near-term budget relief. The rating actions affect $7.8 billion of GO debt, including the current bonds; $556 million of sales tax debt; $1.9 billion of water revenue debt; and $1.3 billion of sewer revenue debt.

SUMMARY RATING RATIONALE

The Baa1 rating on Chicago's GO debt reflects the city's massive and growing unfunded pension liabilities, which threaten the city's fiscal solvency absent major revenue and other budgetary adjustments adopted in the near term and sustained for years to come. The size of Chicago's unfunded pension liabilities makes it an extreme outlier, as indicated by the city's fiscal 2012 adjusted net pension liability (ANPL) of 8.0 times operating revenue, which is the highest of any rated US local government. While the Illinois General Assembly's recent passage of pension reforms for the State of Illinois (A3 negative) and the Chicago Park District (CPD) (A1 negative) suggests that reforms may soon be forthcoming for Chicago, we expect that any cost savings of such reforms will not alleviate the need for substantial new revenue and fiscal adjustments in order to meet the city's long-deferred pension funding needs. We expect that the city's pension contributions will continue to fall below those based on actuarial standards. The city's slowly-amortizing debt levels are also large and growing. The Baa1 rating also incorporates credit strengths including Chicago's large tax base that sits at the center of one of the nation's most diverse regional economies and the city's broad legal authority to raise revenue.

The Baa1 rating on Chicago's sales tax revenue bonds reflects the lack of legal segregation of pledged sales tax revenue from general operations, which caps the rating at the city's GO rating despite strong coverage of maximum annual debt service (MADS). The A2 and A3 ratings on the water and sewer senior and second lien revenue debt reflect the interconnectedness of the two enterprises with the city's general operations. Both systems are departments of the city, governed by the mayor and city council. Ratings on the water and sewer bonds remain above those of the city's GO and sales tax debt due to healthy credit fundamentals and the expectation that any potential increase in the utilities' share of annual pension payments would have a modest impact on the systems' overall financial operations. The difference in the ratings of the senior and second lien revenue debt reflects the stronger legal security and debt service coverage of both systems' senior liens.

The negative outlook reflects our expectation that, absent a commitment to significantly increase revenue and/or materially restructure accrued pension liabilities to reduce costs, the city's credit quality will likely weaken. The formidable legal and political barriers to these actions are incorporated in the outlook. The State of Illinois's constitutional protection of pension benefits raises the possibility that any attempt to reduce accrued benefits will be litigated by plan members. Ongoing unwillingness to sufficiently increase revenue ensures that annual pension payments will remain a considerable operating stress while continuing to fall well below actuarially sound contributions. As such, the city's financial operations will remain structurally imbalanced and the long-term solvency of the city's pension funds will be exposed to a significant degree of asset return risk.

STRENGTHS

- Chicago's revenue-generating capacity is substantial as evidenced by a very large property tax base and a sound socio-economic profile that reflects the city's role as the center of one of the nation's largest and most diverse economies

- Broad legal authority to increase property and sales taxes as an Illinois home rule unit of government

- Recent pension reform legislation passed by the State of Illinois for pension plans of the state and CPD suggests that pension reform legislation is forthcoming for the city

CHALLENGES

- Substantially underfunded pension plans carried a Moody's ANPL of $32 billion (net of enterprise support), equivalent to 8.0 times operating revenue (revenue in the General Fund, Debt Service Funds, and Pension Funds) in fiscal 2012; although actuarial valuations for the city's four pension plans are not yet available for fiscals 2013 and 2014, the city's continued underfunding in the past two years suggests that the plans' unfunded liabilities remain large

- Cumulative underfunding of pension payments relative to actuarially annual required contributions (ARCs) exceeded $7 billion in the period of fiscal 2003 through fiscal 2014; continued underfunding provides the city with near term operating flexibility but hastens the plans' trajectory toward insolvency, which in turn could present extreme budgetary crises for the city

- Despite the prospect for pension cost reductions brought about through state legislation, unfunded liabilities will likely remain large; furthermore, the Illinois Constitution explicitly protects pension benefits, raising the possibility that an attempt to reduce accrued benefits of existing members would face litigation

- City management's legal ability to increase revenue to fund pensions at actuarially sound levels is offset by practical and political limitations to immediately raising taxes so as to support actuarially sound contributions to pension plans

- Operating budget is constrained by fixed costs, namely debt service and pension contributions, which comprise a growing percentage of the city's operating budget; annual pension costs are set to increase by $600 million in budget year 2015

- Direct and overall debt and pension burdens are well above average and growing; the substantial funding needs of overlapping governments exacerbate the practical limitations of generating new revenue from a shared tax base

OUTLOOK

The negative outlook reflects the expectation that, absent a commitment to significantly increase revenue and/or materially restructure accrued pension liabilities to reduce costs, the city's credit quality will likely weaken. The formidable legal and political barriers to these actions are incorporated in the outlook. The State of Illinois's constitutional protection of pension benefits raises the possibility that any attempt to reduce accrued benefits will be litigated by plan members. Ongoing unwillingness to sufficiently increase revenue ensures that annual pension payments will remain a considerable operating stress while continuing to fall well below actuarially sound contributions. As such, the city's financial operations will remain structurally imbalanced and the long-term solvency of the city's pension funds will be exposed to a significant degree of asset return risk.

WHAT COULD MOVE THE GO RATING UP

- State passage of pension reform legislation that survives near-certain litigation to materially lower the city's pension obligations to a level that allows the city to make annual contributions on an actuarially sound basis

- Demonstrated commitment to increase tax revenue so as to fund pension obligations on an actuarially sound basis

- Substantial expansion of the tax base and/or growth in financial reserves that more adequately compensates for the city's exposure to unfunded liabilities

WHAT COULD MOVE THE GO RATING DOWN

- Lack of action by the city and state to arrest the growth of unfunded pension liabilities

- Continued unwillingness on the part of the city to raise tax revenue in amounts sufficient to fund annual pension contributions in line with actuarial standards

- Further growth in direct and overall debt burdens

- Court decision that recently adopted pension reforms by the State of Illinois violate the state constitution

WHAT COULD MOVE THE SALES TAX, WATER, AND SEWER REVENUE RATINGS UP

- Upward movement in the city's GO rating

WHAT COULD MOVE THE SALES TAX, WATER, AND SEWER REVENUE RATINGS DOWN

- Downward movement in the city's GO rating

- Weakening of debt service coverage provided by respective sales tax, water and sewer revenue

RATING METHODOLOGY

The principal methodology used in rating the general obligation debt was US Local Government General Obligation Debt published in January 2014. The principal methodology used in rating the special tax debt was US Public Finance Special Tax Methodology published in March 2012. The principal methodology used in rating the Water and Sewer debt was Analytical Framework For Water And Sewer System Ratings in August 1999. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Matthew Butler
Analyst
Public Finance Group
Moody's Investors Service, Inc.
100 N Riverside Plaza
Suite 2220
Chicago, IL 60606
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Rachel Cortez
Vice President - Senior Analyst
Public Finance Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's Investors Service, Inc.
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JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's downgrades Chicago, IL to Baa1 from A3, affecting $8.3 billion of GO and sales tax debt
No Related Data.
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