November 21, 2024

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KBRA places Chicago on watch for downgrade

3 min read
KBRA places Chicago on watch for downgrade

Chicago Mayor Brandon Johnson faces a pushback by City Council members to his proposed property tax hike.

Bloomberg News

Kroll Bond Rating Agency placed Chicago’s A general obligation bond rating on Watch Downgrade Tuesday as the City Council prepares to vote Thursday on a proposed $300 million property tax increase that Mayor Brandon Johnson included in his 2025 budget. 

KBRA said the rating watch stems from the projected $982.4 million corporate fund shortfall for 2025 and credit challenges such as the city’s reliance on one-time solutions to budget gaps; the risk that the pension payment burden will crowd out other corporate fund spending; Chicago’s reliance on economically sensitive revenue sources; and the late start to the budget process this year, especially given the large projected shortfall.

The rating action comes in connection with plans to sell up to $1.5 billion of debt before the end of the year. KBRA affirmed its A rating on the GOs.

KBRA said it plans to resolve the watch for downgrade by early January.

“We will be watching for passage of a FY2025 budget that sufficiently addresses the structural deficit and does not include an over-reliance on non-recurring revenues or expenditure savings,” Linda Vanderperre, senior director in KBRA’s public finance ratings group, told The Bond Buyer.

The mayor’s proposed budget attempted to compensate for the budget shortfall, which he blamed on a decrease in state and federal funding, with a mix of 80% structural fixes and 20% one-time revenue sources. The property tax proposal represented a reversal of a campaign pledge and followed a report from the Civic Federation of Chicago that said property tax hikes should be a last resort.

Rating agencies such as Fitch Ratings and S&P Global Ratings had praised the inclusion of the property tax increase, calling it “a continuing revenue stream for the city” and “a meaningfully large down payment against the city’s sizable structural budget gap,” respectively.

Last week 29 of the 50 alderpeople signed onto a letter calling for a special separate vote on the property tax increase, and the Chicago Sun-Times reported earlier this week that the tax hike would be “significantly” scaled back in favor of a mix of reprogrammed federal stimulus funds and new revenue. 

“While the proposed $300 million property tax increase was included in the mayor’s recommended FY2025 budget and noted in the city’s rating agency presentation as recently as last Friday, we understand from press reports today that the property tax increase, as originally proposed, has been taken off the table,” Vanderperre said. “We will therefore be looking for consensus between the administration and City Council regarding alternative solutions to balance the city’s budget by the statutorily required date of December 31, 2024.”

While KBRA credits the city for its strong tax base and large, diverse economic base, as well as ample reserve balances that bolster its general fund reserves and liquidity position, it also highlighted some rating sensitivities including potential failure to adhere to established financial and debt policies.

“Here, we are specifically referring to failure to adhere to the city’s budget stabilization fund policy, enacted in FY2016, which requires a balance in the budget stabilization fund… to equal no less than two months’ operating expenses, and failure to maintain compliance with the statutory pension funding ramps for the city’s four pension plans,” Vanderperre said. The budget stabilization fund includes asset lease and concession reserves, the operating liquidity fund and unassigned general fund balance revenue.

KBRA further warned that Chicago’s reliance on one-time revenue solutions “perpetuates structural imbalance and risks compounding outyear costs.” It said the city needs to find more long-term funding sources to address rising fixed costs for pension funding and debt service.

Vanderperre also noted that, regarding the plan to refinance $1.5 billion of the city’s debt, which passed City Council last month, “virtually all debt service savings are structured to occur in budget years 2024 and 2025. The intent of this savings structure appears to be to reduce projected budgetary deficits in these budget years.”

Chicago is rated A-minus with a stable outlook by Fitch. Moody’s Ratings affirmed its Baa3 rating on Chicago early this year, with a positive outlook. S&P assigns the city a BBB-plus rating with a stable outlook.

Chicago’s finance department did not respond to questions about the KBRA watch status by press time.