Fiscal contagion of COVID-19 in Chicago widens

BY SourceMedia | MUNICIPAL | 03/16/20 01:06 PM EDT By Yvette Shields

Chicago Mayor Lori Lightfoot isn’t ready to sound fiscal alarms over the blow to city tax revenues as the city loses convention center, tourism, hotel, and entertainment-related business in an effort to combat the spread of the COVID-19 outbreak.

"As you know the city of Chicago has a very, very diverse economic system" with no one revenue source accounting for more than 13% of tax revenues and economically sensitive revenues representing less than 25%, Lightfoot said in response to a question on city finances last week during Gov. J.B. Pritzker’s daily briefing on COVID-19. The case count hit 93 statewide Sunday with most concentrated in Chicago and Cook County.

“I think we are very well situated,” Lightfoot said. “We obviously did modeling and thinking about the potential for an economic downturn but the bottom line is it's too early for us to measure the entirety of the impact, but we feel very comfortable where we are both as an economy at large but also in terms of revenue sources for the city of Chicago."

The lost business as well as the potential for a more pronounced economic downturn or recession poses short-and-long term strains for a city grappling with a $30 billion unfunded pension tab and trying to reach structural balance by 2022 with its ratings on the line if it backslides.

The governor last week imposed a 30-day ban on gatherings of more than 1,000. That raised to 20 the number of convention shows lost that were expected to draw nearly 200,000 attendees, according to Crain’s Chicago Business. On Sunday, Pritzker imposed a two-week closure of bars and dine-in restaurants.

The city’s finance team acknowledged that the fiscal toll remains unclear but is stressing that short-term there’s sufficient cushion to weather the damage and there’s flexibility to adjust spending.

“It’s too early to tell how long COVID-19 will last or the impact it will have on our local economy. Even though we haven’t seen the fiscal impact at this point, we are closely monitoring our expenses and will make adjustments to our spending, if needed,” a spokeswoman for chief financial officer Jennie Huang Bennett said in a statement. “The city plans for events such as this by including multiple financial scenarios in our budget forecasting for this reason.”

The city in January sold $1.5 billion of general obligation and Sales Tax Securitization Corp. refunding debt that generated an additional $100 million above the $200 million that was included in the 2020 budget. It provides the city with “more cushion in the event of a possible economic slowdown,” the city said Friday.

Short-Term
The city terminated $1.4 billion of existing general obligation and airport credit lines last year to save $22 million in interest and bank fees but stresses it can access the markets to raise liquidity if needed.

The city kept $185 million for emergencies: $100 million in a line of credit that the city has said could be adjusted upward and $85 million in a commercial paper program for Midway airport, according to S&P Global Ratings. “In our opinion, Chicago's liquidity is very strong, with total government available cash at 28.1% of total governmental fund expenditures and 2.5 times governmental debt service in 2018,” S&P said in its last GO review.

Several local bankers said the city enjoys strong banking relationships so it could access lines. Several banks offered various forms of support when defaults on bank support were triggered after Moody’s Investors Service cut the city’s rating to junk in 2015. The city restructured debt to shed its GO floating-rate and swap exposure.

The city’s ending balance and the unassigned portion has risen in recent years so it too provides a liquidity cushion, which is important, several market participants said, in a worst-case scenario where banks face a cash crunch in a severe downturn such as the one in 2007 and 2008 that led to the collapse of the auction rate securities market.

The fund balance rose to $332.3 million in 2018 from $288.4 million in 2017 with the unassigned portion rising to $161.9 million from $155.5 million after hitting a low of $33 million in 2012.

The city’s books benefit from a $550 million long-term reserve set up with the 2005 Skyway toll road lease and it has deposited $20 million into an operating liquidity fund in $5 million increments over the last few years. The city has access to several billion when cash and investments are combined.

The stock market turmoil that ended a decade long bull market also poses trouble for a pension system with a 24% funded ratio. Contributions to police and fire funds rose to an actuarial level this year with the municipal and laborer funds scheduled to hit an actuarial level in 2022 when the total contribution hits $2.1 billion. The investment returns are smoothed over five years so a big hit will set back funded ratios that already will take years to improve but its impact will be muted.

Long-Term
A recovery in the coming months may make the near-term hit manageable as does the potential for federal stimulus help. However, a prolonged hit or recession could set back city efforts to stabilize its budget and pension system.

“The city will be locked into negative amortization for several decades, meaning that the unfunded liability will continue to rise even as contributions increase, and the plans will remain vulnerable to adverse experience and at risk of insolvency due to recession or other exogenous shocks,” S&P warned.

Tax revenue blows and a potential recession add to the urgency for state lawmakers to pass the city’s proposed casino and a property transfer tax changes. The city is banking on the two to eventually generate about $300 million in new revenue.

“Should the city fail to achieve legislative support or implement contingency measures to narrow its budget gap for fiscal 2021 and place it on a path to structural balance by 2022, we could consider a downgrade,” S&P warned. A draw on its long-term lease reserves poses another rating threat.

“The health, safety and welfare of your citizens must come before any other financial priority,” said Richard Ciccarone, president of Merritt Research Services. “The political reality is that all governmental levels must work through these situations together” and that means tapping the markets if needed is justifiable.

Then comes the aftershock. Chicago has benefited from the market’s thirst for any extra yield and that has cut its yield penalties in half. If market dynamics shift to a prolonged flight to quality, investors will be looking more closely at Chicago’s risks.

“There will be more sorting out of the good vs. bad and that’s where Chicago has to be concerned,” Ciccarone said.

“There’s no question of the expectation that there will be a hit to revenues associated with tourism and convention center activity and sales taxes, so they will have to figure out how to replace them or cut spending,” Ciccarone said. “Fortunately the city has built up its cash position and it’s just in time.”

The city’s situation grows more precarious in a prolonged and earlier-then-expected recession. “Chicago is more sensitive because of its pensions and every dollar is precious to the city and the state also, and we do get hit more than others because Chicago is a global city and this is a global problem,” Ciccarone said.

Chicago carries ratings of Ba1 from Moody’s Investors Service, BBB-minus from Fitch Ratings, A from Kroll Bond Rating Agency, BBB-plus from S&P Global Ratings.

The uncertainty was underscored in a Fitch Ratings’ special report Thursday. Analysts consider most states and local governments to be well-positioned to absorb the near-term credit implications but “some governments, as reflected in lower issuer default ratings, are more vulnerable to budget strain from unexpected stress events such as the coronavirus pandemic.”

“Ongoing market declines could increase pension liabilities and contribution needs over time,” Fitch said. “Fitch is assessing whether specific governments face near-term credit risk in this evolving situation.”

TAX REVENUES
Property taxes are a big revenue source for the city at $1.5 billion in 2020 but it mostly goes to cover debt service and pension payments so the city’s general fund, known as the corporate fund, doesn’t rely on it.

Local tax revenues make up about $1.8 billion of the city’s $4.46 billion corporate fund. The budget totals $11.65 billion when all funds are included.

Transportation taxes include taxes on parking, vehicle fuel purchases, and the rideshare taxes that all total $383.6 million, or 8.6% of the corporate fund. Ridesharing makes up $190 million of that figure with an additional $40 million coming from a tax hike.

Recreation taxes include taxes on amusements, automatic amusement devices, the mooring of boats in the city’s harbors, liquor purchases, cigarette and e-cigarette purchases, purchases of non-alcoholic beverages, and offtrack betting are projected to generate $273 million, or 6.1% of the corporate fund.

Business taxes on hotel accommodations and on paper and plastic disposable shopping bags and make up $134.4 million of the corporate fund. The hotel tax accounts for $128.5 million of that figure.

The city will receive $615.5 million in residual sales tax collections after the Sales Tax Securitization Corp. releases collections not needed to repay bonds sold since 2017 to refund other city debt at lower costs. The city’s own sales tax collections not sold to the STSC and retail are projected to generate $74 million. That figure includes restaurant taxes.

In general the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so avoiding losses caused by price volatility by holding them until maturity is not possible.

Lower-quality debt securities generally offer higher yields, but also involve greater risk of default or price changes due to potential changes in the credit quality of the issuer. Any fixed income security sold or redeemed prior to maturity may be subject to loss.

Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.

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