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Bates Research  |  05-15-15

Chicago Debt Downgraded

Moody's took the city of Chicago's debt rating below investment-grade on Tuesday, marking the first time since Detroit that a city has fallen below that line. The concern for Chicago centers around its underfunded pension liabilities, which, without reform, will present a serious problem for the city.

Moody's acted in response to a May 8th ruling by the Illinois Supreme Court, which ruled as unconstitutional a law that would have reduced the amount of post-retirement income owed to pensioners. While pension-eligible workers may have celebrated the decision, it leaves the city on the hook for $62.3 billion in obligations, or about $23,000 per Chicago resident. Even stripping out obligations related to Cook County as a whole, that figure still stands at $29 billion. In Moody's opinion, the court ruling will restrict options for the city government, and will leave them with tough choices to make related to program funding and repayment. The rating itself was dropped from Baa2 to Ba1 (a three-notch drop), which affected about $9 billion in debt. Moody's maintains a negative outlook on the city as well, with future downgrades possible if the city cannot come up with a compelling solution. A few months ago, Moody's dropped its rating of Chicago from Baa1 to Baa2, indicating that the agency has kept a close watch on the city's finances so far in 2015.

Mayor Rahm Emmanuel, who just won a second term last month, now faces some hard tasks. First, the downgrade has triggered an estimated $2.2 billion in additional repayment that lenders are now entitled to. The mayor had planned to tap markets to raise an additional $1.1 billion as well ($900 million to retire floating rate debt and $200 million for swaps associated with those bonds). It's unclear if the city will still be able to issue bonds at fixed rates low enough to make this exchange worthwhile.

While some commentators have already begun to compare the situation in Chicago to the situation in Detroit, for now all the rating agencies do not seem to agree, and that may buy Mayor Emmanuel some time. S&P and Fitch have both maintained much higher ratings on the city, sitting at A+ and A- respectively, indicating that they must have an alternate narrative for its future. Markets, however mixed, seem to be taking the downgrade as signal to get out -- perhaps as a result of being caught off guard by problems with other municipal issuers over the last several years. The debt of both the city of Chicago and Illinois in general has been trading down in markets.