March 5, 2015
Even after lowering the City of Chicago’s bond rating another step last week, Moody’s Investors Service maintains a negative outlook on the City, heightening the risk of additional ratings actions and possibly increasing termination costs on its swap agreements.
On Friday February 27, 2015 Moody’s reduced the City’s General Obligation Bond rating by one step to Baa2 from Baa1. This move triggered the termination clauses of several of the derivative instruments tied to the City’s variable rate bonds, also referred to as swaps.
According to the Moody’s report, four of Chicago’s 14 swaps contracts require the City to keep a bond rating of Baa1 or higher. Due to the cut in its rating, the City must pay the mark-to-market value of the contracts or renegotiate the terms with the banks that are counterparty to the deals. The report accompanying the downgrade stated that four swaps with a termination threshold above the current rating have a negative mark-to-market value of $58 million.
However, on March 4, 2015 it was reported that the City had established new terms with at least one of the banks, BMO Harris, to avoid owing roughly $20 million in termination costs at the current rating level. The change in the contract lowered the liability to approximately $40 million to Wells Fargo according to a statement provided to the media by the City. The City stated that talks are ongoing with Wells Fargo about the termination of its swaps due to the downgrade. The terms of the renegotiation with BMO Harris have not been publicly disclosed nor have the renegotiations on the other swaps that appear to have been changed since June of 2014.
The Official Statement published as part of the September 2014 bond offering by the City showed that as of June 30, 2014 the entire portfolio of 14 swaps associated with its general obligation debt had a negative value of $147.3 million. At the time 10 out of the 14 deals included a ratings threshold of Baa1 from Moody’s and would have been terminated if the rating was lowered just one level. The remaining four were split between thresholds at Baa2 and Baa3.
The information in the report accompanying the latest downgrade from Moody’s showing that only four of the swaps faced termination or renegotiation at Baa2 represents the only publicly available information that the swaps portfolio had been modified further since the September 2014 bonds were issued.
An article published in the Chicago Sun-Times on June 19, 2014 indicated that the City was in the process of renegotiating its swaps. The article stated that the City would face $110.4 million in swaps termination costs if Moody’s lowered its rating to Baa2 and an additional $88.5 million if it was lowered to Baa3.
Due to the variety of estimates and lack of current information available on the City’s debt management website, it is unclear what ratings thresholds and cost are remaining in the portfolio. The banks other than BMO Harris and Wells Fargo that are counterparty to Chicago’s swap deals are PNC, Goldman Sachs, Bank of New York Mellon, Deutsche Bank and Morgan Stanley.
As previously discussed here, the City experienced a triple downgrade in June 2013 from Moody’s and another single downgrade in March 2014 prior to the most recent ratings cut. The agency warned that if the Illinois Supreme Court rules that the State’s pension reform package violates the Illinois Constitution or if there is a court determination that the City’s pension reforms for the Municipal and Laborer’s Funds are invalid, it would likely trigger additional ratings actions.
In the last week, the other two major ratings agencies, Standard and Poor’s and Fitch, affirmed ratings for Chicago of A+ and A- respectively. Both maintain a negative outlook on the City.