CENTENNIAL (S&P Global Ratings) Oct. 23, 2020--Chicago's $4.0 billion proposed corporate fund budget released on Oct. 21 aims to fill an estimated $1.2 billion 2021 fiscal year revenue shortfall with both one-time and structural solutions. Approximately 53% of the budget solutions come from one-time measures, primarily $500 million in savings from restructuring outstanding debt. Structural solutions make up about 47% of the gap and include layoffs, a property tax increase and other efficiencies. The 2021 budget is a 9% decrease from 2020's $4.4 billion budget.
Chicago is also using one-time measures to address the nearly $800 million revenue shortfall in 2020. Rather than using reserves as the basis for major one-time solutions in 2020 and 2021, the city is relying on refunding and restructuring outstanding general obligation and sales tax-backed debt issued by the Sales Tax Securitization Corp of Chicago. This approach increases the city's fixed costs and can limit flexibility in the future by elevating the debt burden and extending the final maturity. However, it also allows the city to keep reserves on hand to fill future budget gaps or revenue shortfalls, if needed. Strong and stable reserves are a high point for the credit, and at fiscal year-end 2019 reserves totaled $1.0 billion or 27% of general fund expenditures. Liquidity remains similarly strong with approximately $1.5 billion on hand at any time.
In the current economic and fiscal environment, we expect many issuers who are usually structurally balanced will use some one-time measures to address current and future year shortfalls; in these cases, we evaluate how one-time solutions fit into the issuer's bigger picture for achieving structural balance over the long term. In the case of Chicago, we have long considered the city to be structurally imbalanced given chronic underfunding of its pension contributions. In 2020 the city started contributing the full actuarially determined pension contribution for its police and fire pension funds, but is on a ramp-up for full actuarial funding for municipal and laborers in 2022, currently estimated to be an increase of $1 billion between 2019 and 2022. An expenditure increase of this magnitude would be difficult to tackle at any time, but becomes particularly challenging given current recessionary pressure. The city's ability to absorb the additional pension expenditures and stay on a course to structural balance will be critical to maintaining the rating.
The city structured the 2021 budget with a stated goal of achieving structural alignment. In our view, how the city sets itself up in 2020 and 2021 to meet the challenges of 2022--including the pension ramp-up--is of critical importance to the rating. In April 2020, we revised Chicago's outlook to negative, reflecting our expectation that meeting the pension ramp-up and regaining structural balance was made markedly more difficult by COVID-19 and the recession. If the city's final budget and management's plans to address potential pressures beyond 2021 don't make sufficient progress to return to structural balance, the rating will be pressured further. In our view, a sustained deterioration in liquidity or reserves could also negatively pressure the rating. The city expects to adopt the final budget in late November.
Pension Pressures Remain Acute
As of year-end 2019, Chicago's four funds (police, fire, municipal and laborers) had a combined funding level of 23.6%. When Chicago reaches its full actuarially based statutory payments of $2.25 billion in 2022, it will be nearly $1 billion more than their contributions in 2019. Even with such a sizable contribution increase, it will still only keep the city on pace to fund 90% of the liability over 40 years, which we consider slow. The hefty pension burden puts the city's fixed costs (debt service, full actuarially based pension payments and OPEB pay-go) at an extremely high 47% of total governmental funds expenditures in 2019 In addition, given the magnitude of the problem and reliance on market returns to stay on track with pension funding, it is possible that even if the city takes all the right steps to align expenditures with revenue, effects from COVID-19 and the recession could still result in fund performance that sets funding levels further back.
This report does not constitute a rating action.
|Primary Credit Analyst:||Jane H Ridley, Centennial (1) 303-721-4487;|
|Secondary Contacts:||Carol H Spain, Chicago (1) 312-233-7095;|
|Scott Nees, Chicago (1) 312-233-7064;|
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