Chicago needs revenue strategy to continue ratings improvement, agencies say

Chicago’s bond ratings have improved, but the city has more work to do, even after the recent passage of Mayor Brandon Johnson’s $16.77 billion 2024 budget by an overwhelming majority of the City Council on Nov. 15.

While the city has made some important progress on the expenditure side, the new mayor’s first budget didn’t make similar strides on the revenue side, according to Fitch Ratings, which upgraded Chicago’s general obligation debt to BBB-plus from BBB in October. For example, the budget didn’t include raising the property tax levy to account for inflation, which had been included under the previous administration.

Fitch’s upgrade, which didn’t hinge on passage of the budget, cited “a decline in the city’s long-term liability burden stemming from steady growth in the economic resource base and improved debt management practices,” including making advance payments on its big pension obligations.

While that is “putting positive pressure on the rating, our upgrade was not a reflection that the new administration has put forth a budget that we believe meaningfully improves the credit quality of the city,” Ashlee Gabrysch, the rating agency’s Midwest regional manager, said after the budget was passed.

While the city’s overall debt burden and pension liabilities have moderated and are “better aligned with the BBB-plus rating,” its liability related to debt and pensions remains high and continues to weigh on its overall spending plan, added Michael Rinaldi, senior director and head of Fitch’s local government  ratings group. That “consumes a considerable degree of operating resources, and that is unchanged.”

Fitch assigns a stable outlook to Chicago.

Chicago’s credit quality “is heavily pressured by its expenditure burden and a lot of that cannot be cut,” Gabrysch said.

“And if that cannot be cut, then you have to raise revenues to absorb those growing expenditures and to meet any additional expenditures that the new mayor hopes to bring online for new policy programs. The one piece of the budget that was not there was any sort of growth in new or existing rates for revenues,” she said.

Johnson has kept his campaign promise to shield property tax levies from inflation, at a cost his administration estimated at $90 million.

“There were no offsetting actions that addressed the lower revenues as a result of eliminating the inflation adjustment on the property tax levy,” Rinaldi said. “So it leads to a structural imbalance when you’re taking away revenue without cutting costs elsewhere or replacing that particular revenue loss with growth in revenues from other sources. So I think the revenue part of the equation for the city going forward needs to be addressed. It could be challenging for the city to sustain a structural balance from expenditure actions alone.”

On the positive side, Gabrysch acknowledged that the budget included a supplemental payment of $307 million toward the city’s pension liability, continuing the policy of Johnson’s predecessor Lori Lightfoot. Johnson, who was elected in April, has said he plans to keep making those additional contributions, on top of the amount required by law, until 2026.

“Given the funding level of the pensions, that is a positive aspect, unlike the rosier revenue forecast, which may or may not come to fruition,” Gabrysch said.

On Nov. 10 Kroll Bond Rating Agency affirmed its A rating of Chicago and positive outlook. While noting that the city has made nearly $550 million in supplemental payments on its pension obligations in the past two years, the funds “remain severely underfunded, with a combined net pension liability of $35.5 billion” as of year-end 2022, the rating agency said.

“There is a remaining challenge to identify recurring revenue sources to meet fixed costs for the aforementioned pension plans, which are additive to other long-term liabilities, and represent a significant claim on current and future resources,” Kroll said in its report. The city “needs to identify significant long-term funding sources as pension funding transitions to an actuarial schedule. Continued reliance on economically sensitive revenue sources poses ongoing budgetary uncertainty.”

Following the budget passage, Kroll is “monitoring progress toward structural balance through reduced reliance on non-recurring revenue sources, in the context of still elevated inflation and associated cost pressures, asylum seeker-related expenditures, potential economic headwinds, and post-utilization of all federal recovery funds,” said Harvey Zachem, a managing director in Kroll’s Public Finance Ratings group. 

The Chicago Civic Federation, a local watchdog, said it supported Mayor Johnson’s budget but warned that the “ongoing structural imbalance in the city budget and several financial strains could be a drag on the city’s long-term financial success if they are not addressed.”

The group noted that the budget “relies on several one-time revenue sources to close a projected gap of $538 million” and urged “the city’s new leadership to develop a long-term plan for the city’s finances.”

“This budget will get them through the next year, but there are many long-standing challenges the city faces that will require sustainable, long-term solutions from both the Mayor and City Council.”

The city’s general obligation bonds are rated Baa3 by Moody’s Investors Service, with a stable outlook and BBB-plus by S&P Global Ratings, with a positive outlook.