Moody’s upgrade mends relationship with Chicago

With its investment grade status restored, Chicago plans to ask Moody’s Investors Service to rate its upcoming general obligation deal, bringing an end to a schism that followed the rating agency’s decision to cut the city to junk.

Moody’s raised the city’s GO and issuer rating to Baa3 with a stable outlook from Ba1 on Tuesday following the City Council’s passage of a $16 billion budget for 2023 that provides a supplemental pension contribution and launches a policy aimed at staving off growth of the $33.7 billion net liability tab.

“We will ask Moody’s to rate the upcoming issue,” Chicago’s Chief Financial Officer Jennie Huang Bennett said in an email. “We are targeting pricing for early December” on the roughly $757 million sale.

The Moody’s upgrade follows a recent one from Fitch Ratings, lifting the GO, Sales Tax Securitization Corp., and water and sewer ratings. Fitch and S&P Global Ratings upgraded O’Hare International Airport’s general airport revenue and passenger facility charge ratings over the summer. Moody’s also upgraded the water and sewer bonds in tandem with the city’s issuer rating Tuesday.

“The city’s 10 upgrades from independent rating agencies and investment-grade ratings across the board is external proof that the city has turned around its finances,” Bennett said in a statement.

The Moody’s upgrade holds the most practical and reputational benefit as it removes the tarnish associated with a junk label attached to the city’s GO paper even though the city has not asked for a Moody’s rating since 2014. The city will confront a more tumultuous market with yields on the rise, fund outflows and inflationary worries.  

“I think the removal of the junk status gives the bonds more appeal to a larger audience,” said Daniel Berger, senior market strategist at MMD Refinitiv.

The city’s bonds don’t trade frequently but recent trading before the Moody’s upgrade was in the 150 basis point spread range to MMD’s AAA benchmark. The BBB benchmark is currently just under a 100 bp spread to the AAA. Berger expects some narrowing but if the narrowing is slight the paper should draw widespread appeal as it will be viewed as a credit on the upswing that still offers that extra yield kick being sought by investors.

Any further tightening would help the city’s already improving price movement. Chicago GOs have performed comparatively well starting in about the second quarter of 2022, according to the University of Chicago’s Center for Municipal Finance’s municipal index that tracks secondary market price movements of larger cities, counties, and school district GOs.

For most of 2020 and 2021 prices on Chicago GOs were dead last among the 33 cities tracked, said Justin Marlowe, research professor at the Harris Public Policy School at the University of Chicago and editor-in-chief of Public Budgeting & Finance.

At one point in early 2020, many other large city GOs were trading at two to two-and-a-half times their 2018 prices, which is when the center launched the tracking data while Chicago GOs hovered at their 2018 prices. Chicago is now sixth among those 33 cities.

“I think the rating upgrade and comparatively strong prices recognize two important trends. One is Mayor [Lori] Lightfoot’s commitment to fiscal discipline. The other trend is that the market now seems to realize that Chicago’s economic fundamentals will serve it well in the post-pandemic recovery,” Marlowe said.

After the cut to junk, Lightfoot’s predecessor Rahm Emanuel halted communications with Moody’s and later sent a letter asking it to withdraw its ratings. Moody’s continued to rate outstanding bonds. The city’s sister agencies followed suit in halting their relationship with the rating agency.

City officials did not immediately say whether the sister agencies would also resume asking Moody’s for ratings. Moody’s withdrew the Chicago Park District’s rating last year.

Moody’s GO upgrade rippled down to the city’s water and sewer credits but it’s unclear whether it will result in reviews of other credits. “Moody’s has not announced any other rating actions or placed any ratings under review. If we do so in the future, we would announce such an action through a press release,” Moody’s spokeswoman Melissa Mott said.

The city’s efforts to better align its expenses with recurring revenues, shed one-time maneuvers like scoop-and-toss debt restructuring, and the implementation of a pension funding overhaul — begun under Emanuel and continued by Lightfoot — to reach an actuarially based pension contribution provided the underpinning for the upgrade.

But it was the administration’s move to tap surplus revenues to make a supplemental contribution of $242 million — the amount needed to stave off growth of the legacy unfunded tab — and its plan to continue that funding policy in future years that cemented the upgrade.

“The supplemental payment was really the culmination of a multi-year effort but the significance of the supplemental payment really is that for the first time the city is targeting a contribution that will stop the pension problem from getting worse,” Moody’s analyst David Levett said in an interview along with analyst Rachel Cortez. “This policy really turns the corner” and “was a key driver” of the upgrade.

The tab’s size along with overall liabilities will still weigh on the city’s balance sheet. “This is investment grade but it’s the lowest investment grade rating because they still have a pretty big liability,” Cortez said.

The city’s pension strains have long played a dominant role in its Moody’s rating. The May 2015 drop into speculative territory followed an Illinois Supreme Court ruling overturning state pension cuts, finding they violated strict state constitutional language protecting benefits from any impairment. The city’s pension funding revamp later suffered the same fate.

Emanuel revised the overhaul putting the four funds on a payment plan that ramped up contributions to hit an actuarially based formula in 2020 for police and fire on a path to 90% funding by 2055 and this year for municipal and laborers with a 90% target in 2057.

The downside of the new schedule is the years it takes to overcome the tread water mark, where the legacy tab is paid down, leaving funding ratios weak for decades and their health vulnerable in years when investment returns fall short of assumed rates of return. That remained a sticking point for Moody’s.

Under the statutory policy, the unfunded tab was expected to keep growing for nine years. Instead, the level will hold steady and began falling more quickly under the new supplemental contribution policy. Funded ratios improved slightly in 2021 but remained weak in a range between 21% and 46%. The statutory contribution and $242 million supplemental contribution will bring the total payment for 2023 to $2.7 billion.

While the restoration of investment grade marks a milestone, the rating remains weak at the Baa3 level compared to the median for all cities nationally, which is in the double-A category.  

Climbing the investment grade ladder will take work, including chipping away further at pension and debt levels, raising already healthy fund balances and liquidity, and local economic growth that bolsters financial indices.

“One thing we are looking to is a continuation of paying pensions in accordance with this new policy. It won’t be easy” in the case of investment losses that will raise the supplemental burden or if the city faces other fiscal demands, Cortez said. The policy is not codified in ordinance and Lightfoot faces challengers as she seeks a second term next year.

Back-peddling on progress by skipping out on the supplemental contributions that allows net liabilities to grow, taking on a substantial degree of additional debt and a weakening fund balance could drive a rating cut. “Relaxing this policy could result in downward movement of the rating,” Cortez said.

Moody’s raised the senior lien water and sewer ratings to Baa1 from Baa2 and the second lien sewer bonds to Baa2 from Baa3. All are stable. The city carried $3.6 billion of GO, $2.3 billion of water, and $2 billion of sewer bonds at the close of 2021

Fitch now rates Chicago BBB with a stable outlook. Kroll Bond Rating Agency rates Chicago A and stable and S&P Global Ratings rates the city BBB-plus and stable.