This is what counts as excitement in my biz.
Other than bankruptcy filings.
CHICAGO – Fitch Ratings in a report Wednesday criticized Moody’s Investors Services’ recent assessment of Chicago Public Schools’ new credit structure and the legal options available to ease its distress.
The report titled “Fitch Disagrees With Moody’s Legal Analysis On Chicago Public Schools” was published to counter arguments laid out by Moody’s in special credit profile reports published Jan. 12 about the city and CPS.
Fitch’s public dissection of another rating agency’s opinions was described as “highly unusual” by several market participants.
“This is uncharted. Very rarely except on panels at conferences would you have this sort of open debate or defensiveness,” said Howard Cure, director of municipal research at Evercore Wealth Management, LLC. Cure worked for Moody’s until 1994.
Moody’s has not been asked to rate new deals by either issuer, but maintains junk ratings on their older debt.
Some suggested that Fitch’s motive for publicly calling out a peer rating agency may stem from market questions received after Moody’s released its commentary.
Fitch said that wasn’t the case.
“We read it and we didn’t feel all the information was correct and felt it would helpful to the market if we posed our reasons as to why we disagreed,” said the report’s co-author, Amy Laskey, a Fitch managing director.
Fitch outlines its disagreement with Moody’s on several aspects of its legal assessment of CPS’ new capital improvement tax-backed bonds. The district used the new property tax levy for the first time on a $730 million sale in December.
The deal garnered an A rating from Fitch based on analysts’ confidence in its bankruptcy-remote structure.
CPS asked only Fitch and Kroll Bond Rating Agency to review the bonds. Kroll assigned its BBB rating in line with its GO ratings of BBB and BBB-minus.
Fitch rates CPS GO debt B-plus, with a stable outlook. The other two rating agencies also rate CPS GOs at junk.
Fitch countered Moody’s suggestion that triggering the ad valorem tax pledge used on most of its $6 billion of debt offered one option for CPS to free up revenue for operations.
Fitch quoted Moody’s report suggesting that the district could elect to use unrestricted general state aid for operations instead of debt service on its alternate bonds issued under the Illinois Local Government Debt Reform Act.
Moody’s spokesman David Jacobson had no direct response to the Fitch report, saying his agency’s Jan. 12 speaks for itself.
Cure said Moody’s opinion “carries weight with the market.”
He noted that the city of Chicago’s recent GO deal priced at junk levels, even though Moody’s is the only rating agency to rate Chicago at junk. CPS’ 30-year CIT bond – despite the Fitch A rating and BBB from Kroll – landed 309 basis points over the Municipal Market Data’s top-rated benchmark, 243 basis points over the single A benchmark, and 207 basis points over the BBB benchmark.
Moody’s January reports were released ahead of Chicago’s $1.16 billion GO sale and followed the city’s disclosure that it had asked Moody’s to withdraw all of its city ratings in December. Moody’s declined to withdraw.
CHICAGO, Feb 1 (Reuters) – Fitch Ratings took aim at its credit ratings competitor Moody’s Investors Service in an unusual and blunt public notice on Wednesday with a report detailing disagreements over its analysis of the Chicago Public Schools bond payment protections.
Fitch attacked conclusions Moody’s reached in a Jan. 12 report on the nation’s third-largest public school system, which is struggling with escalating pension payments, drained reserves and debt dependency.
Amy Laskey, a Fitch managing director, said Wednesday’s report was not requested by Chicago Public Schools (CPS) or anyone else.
“We felt like it was something that should be clarified and would be helpful to investors,” she said.
Fitch disagreed with Moody’s conclusion that state aid dollars pledged to pay off the district’s alternate revenue general obligation bonds could be diverted to operations and said such a move is prohibited by Illinois law.
Moody’s, which rates CPS deep in the junk level at B3 with a negative outlook, has not been asked by the district to rate its bond issues since 2013. In December, Chicago Mayor Rahm Emanuel, who controls CPS, asked Moody’s to withdraw the junk rating it maintains for the city.
CPS cannot file for municipal bankruptcy in Illinois, although there have been attempts to change state law to allow such a move.
FIGHT! FIGHT! FIGHT!
Rahm Emanuel chose Fitch and Kroll to rate the bonds. There’s a whole perverse incentive structure in muni bond ratings — the issuer pays rating agencies, and have the ability to share private info with those agencies.
But, because of the First Amendment, credit rating agencies can issue their opinions about any bond issue they want. Rahm can bitch at Moody’s for its ratings, but they can’t do a damn thing about it. They already decided not to pay Moody’s in 2013, so there’s not much in the way of levers.
The credit rating agencies pretty much only have their reputations going for them (though they get some regulatory boosts), and some of the agencies decided post-credit meltdown of 2008 that they needed to work on their credibility.
Crumpling over political threats doesn’t do much in the way of building one’s reputation.
Before I make further comments, let me point out another credit rating issue. To wit, Trump’s threat over sanctuary cities.
President Donald Trump’s decision to authorize a federal funding cutoff to sanctuary cities is “unlikely” to impact Chicago’s shaky bond rating — “at least in the near-term.”
In an advisory issued Wednesday, Standard & Poor’s said its preliminary analysis of Trump’s executive order is that it’s “unlikely to immediately affect federal funding streams” to sanctuary cities because of “established statutory limitations of the executive branch withholding or deferring such funding.”
But the bond rating agency threw in a caveat.
“If the executive order is subsequently backed by congressional action authorizing the withholding or deferral of funding, and that action withstands judicial scrutiny, the impact of the funding reduction could be more pronounced in the absence of any financial mitigation,” the report states.
With S&P, Chicago’s bond rating stands at BBB-plus with a stable outlook. The outlook was changed from negative to stable after the City Council approved Mayor Rahm Emanuel’s plan to slap a 29.5 percent tax on water and sewer bills to save the largest of four city employee pension funds.
There are various uncertain Trump effects in the financial world. I have to keep tabs on it for my day job… I’m not doing much with this right now on the blog, as I see a lot of uncertainty… and Trump’s attitude may be irrelevant depending on what Congress does.
THE MARKET HAS ITS OPINIONS
Let’s check in with the bond market. Surging Muni Yields in Chicago Send Warning Signal
Chicago’s sale of $900 million general obligation bonds last week came at a high price and has some muni strategists worried about what comes next.
Matt Fabian of Municipal Market Analytics wrote to clients Tuesday:
The deep price concessions made by Chicago to complete its $900M GO sale last week are a point of concern both for the city and for the market at large. Yields near or north of 6.0% represent spreads more than 100bps wider than the city’s last GO sale in January 2016 and are roughly double benchmark 5% AAA nominal yields.
He notes that the city’s bonds are trading near Chicago Public Schools, which he thinks is appropriate, but it isn’t the way investors typically see things.
The latest pricing has him worried enough that it reminds him of Puerto Rico, circa 2013, when the Commonwealth started to lose access to capital markets. He writes:
The high nominal and relative yield levels draw comparison to PREPA’s beginning-of-the-end 7%’s in 2013, and raise concerns that the city is in the first stages of losing economic market access. MMA does not believe that that has to be the case; however, perceptions of insolvency can be difficult to shake without convincing and sustained positive credit momentum.
…and the Chicago Public Schools couldn’t hide all the problems….
FINANCIAL STATEMENT READER BEWARE
CHICAGO – Chicago Public Schools, in its latest financial report, warns of more red ink to come this year and “difficult” decisions next year without additional state help.
“The long-term future sustainability of the district at its current operating level is dependent on new revenue sources or major reductions in costs,” the district warns in a footnote about “future sustainability” in its comprehensive annual financial report for fiscal 2016, which ended June 30. The report was submitted to the Chicago Board of Education last week.
State pension funding help and pension reforms are crucial to help keep the district afloat. Coupled with district cuts and other cost saving initiatives CPS says it can return to the black.
“Without these actions, CPS may be in a deficit cash position in fiscal year 2017 and without additional funding, CPS will need to make difficult decisions to balance fiscal year 2018 and future budgets,” it says.
The district’s 2017 budget relied on $420 million in additional state funding although $215 million is at risk. Gov. Bruce Rauner vetoed the funding late last year in the absence of a state agreement on pension reforms.
A Senate plan to break the state’s 18-month-old budget impasse would resurrect that funding but its fate is uncertain. The proposal also includes an overhaul of state aid funding formulas based on the recommendations expected as soon as this week from a special commission.
CPS closed the books on fiscal 2016 with an operating deficit of $537 million, down from a gap of $710 million in fiscal 2015. Its fund balance landed at a negative $127 million and it unrestricted net position – which looks more fully at its fiscal picture and includes assets and outstanding obligations — was at a negative $12 billion, an increase of $759 million from fiscal 2015.
CREDIT CLUSTERS BITE
CHICAGO — Chicago’s widening spread penalties may not ease until the state cleans up its budget mess and Chicago Public Schools shores up its rocky finances.
That’s because the city’s fortunes are now more closely linked to the distressed district and a dysfunctional state government in what’s known as “credit cluster risk,” say market participants.
The higher spreads Chicago had to pay on its January general obligation bond sale – despite some good news from three rating agencies after Mayor Rahm Emanuel pushed through tax hikes to improve pension funding – illustrate the market’s imposition of the cluster risk contagion on its GO paper.
“The credit cluster concept goes beyond simple geographic location and includes other fundamental credit interdependencies,” said Triet Nguyen, head of public finance credit at NewOak Credit Fundamental. The city, school district and state government trio is a “poster child for this concept, due to the overlapping tax base as well as the fiscal interdependence between the state, the city and the school district.”
When a municipal government suffers severe fiscal problems, be it a city, county, school district, utility district, or any other special purpose government, those problems have a tendency to impact or be shared by other governments. Bond markets identify this interconnectivity, and apply broad brushes discounting borrowers sharing common elements with the troubled municipality.
The starting point for state and local cluster concentration is common geographic and economic interplay. However, unique characteristics of individual governments can compound or mitigate these forces.
Weak state financial condition normally leads to declining support for local governments. State laws limiting revenue flexibility and promoting or allowing poor financial management can have negative effects. Conversely, political cultures that support good government and co-operation between governmental units and intervention when there is trouble are better able to handle distressed situations.
States can cut back appropriations, mandate increased spending by local governments or otherwise make unfunded mandates. States can also make statutory changes limiting local government taxing powers, or redirect funds back to state governments. State willingness to intervene can often be a positive. However, when cluster contagion occurs, and multiple local units of government need assistance simultaneously, it can create a significant burden even on states with healthy financial positions.
Common Elements of Local Cluster and Contagion Risk
Negative Population Trends
High Overlapping Debt and Pension Liabilities Per Capita
Taxing Capacity – Both Ability and Willingness to Pay
Deferred Infrastructure Improvements
There are also other secondary symptomatic factors which may signal that cluster risk might be festering, such as median household income, the median age of a county’s housing stock and the overall condition of the central city’s unrestricted net position relative to the size of the city’s total governmental expenditures.
Illinois and Chicago as Examples of State and Local Cluster Risk
Illinois is a prime example of cluster risk at work. Its chronic failure to maintain adequate appropriations to fund its public pensions on an actuarial basis has left the state with a huge budget gap to cover escalating pension costs. The state’s constitutional protection clause that prohibits the diminishment of pension payments to workers, upheld by the State Supreme Court, appears to have left the state in a highly difficult position to close the gap without dramatically raising taxes or reducing services. The severity of the burden has left state leaders with differences on the need for serious reforms and in conflict as how to solve the issue. The net impact has resulted in a deadlocked legislative and executive standoff with no state budget approved for the entire 2016 fiscal year. This unusual situation has resulted in substantial de facto cutbacks to departments or programs that didn’t receive protection either under a Court order, automatic appropriation protection or a legislative consent decree. Throughout the standoff, public universities, state aid educational appropriations and social service funding were among the spending needs that were most affected. At the same time, an urgent request for additional support from Chicago governments, including the Chicago Public Schools, has fallen short of its needs. The state’s own credit distress has led to numerous credit downgrades by the rating agencies and higher borrowing costs for state agencies and local government borrowers. (A temporary budget fix is still ongoing for the first half of FY 2017).
For these reasons, Illinois is probably the current headline epicenter of cluster and contagion risk among the fifty states. The situation is exponentially compounded by co-incident major fiscal challenges that currently exist in the City of Chicago and the Chicago Public Schools. At both the state and local levels, the root issue of the Illinois problem emanates from its long time failure to adequately address its underfunded public pension funds. Illinois’s economy, tax base and debt levels are so interconnected with Chicago that it is highly difficult to isolate the fiscal problems that exist for taxpayers in the Prairie State. Recent fiscal shortfalls have had an adverse waterfall effect on a number of associated state agencies and many local units.
INJECTION OF REALITY
It’s cure that Fitch and Moody’s are scrapping over legal issues. I am not a lawyer of any type and will not argue what is and is not legal re: public finance.
I will talk about money running out.
You can say it’s “illegal” not to pay certain obligations, but if there’s no money there to cover it… well… suing won’t make that money appear from nowhere.
So yes, the legal issues are useful in terms of determining priorities of cash flows. But just because a legal bankruptcy process may be barred (as with the states), the reality can be that many promises will be broken.
And yelling “BUT YOU PROMISED!” or lawyering up won’t necessarily fix it.
Detroit is a good lesson. Yes, the pensions got partly whacked, but the bond holders really got whacked.
Push comes to shove, who do you think will be required to take a cramdown? Legal bankruptcy or no? Do you think the pensions will get hit first?
The credit cluster/contagion issue is to the point. At least Michigan could do a mini-bailout of Detroit. Michigan as a state was doing considerably better than Detroit.
Illinois is not doing considerably better than Chicago. It’s got a huge debt/deficit problem, too. How is the state to bail out Chicago?
So I will let various lawyers continue to scrap over who will get first bite at cash flows.
We will see what the judges say later. I know what judges have said in the past.
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