Chicago’s Controversial Sales Tax Bonds

This week the City of Chicago began marketing $575 of rated debt backed by its share of sales-tax revenue received from Illinois.  The bonds, issued by the Sales Tax Securitization Corp., are controversial because of the ratings that they have and the ratings that they do not have.

The bonds are rated AAA by two rating agencies, Fitch and Kroll.  Rating agencies issue their rating opinions when they are paid to do so by the issuer.  Often when the two most well-known bond raters, Moody’s Investors Service and Standard & Poors’, do not rate a bond, it is because their rating would have been too low in the eyes of the issuer.

That Moody is not rating the bonds of the Sales Tax Securitization Corp. is significant because in June of this year, Moody’s downgraded its ratings on the Chicago Transit Authority’s (IL) Sales Tax Receipts Revenue Bonds.  Like the bonds of the Sales Tax Securitization Corp., the Chicago Transit Sales Tax bonds rely on remittances collected by the State of Illinois on its behalf.

Moody’s stated that it downgraded the CTA Sales Tax bonds because “the state has allowed a backlog of payments owed to CTA and other public- and private-sector entities to rise to record levels ($14.68 billion in aggregate as of June 5, according to the state comptroller). This prolonged impasse is putting pressure on various entities like CTA that are awaiting payment from the state. While the practical effects for CTA have been limited so far, the authority has exposure to the deteriorating state government.”

In other words, notwithstanding good intentions and academically fine legal documentation, when money is tight and push comes to shove, politicians will allocate funds based on realpolitik first and foremost.

The Chicago CTA Sales Tax bonds only suffered a downgrade, not a default.  Bondholders of a similar sales tax securitization issued by Puerto Rico suffered a default in May of this year when a US Federal judge ordered a stay on those payments, pending a resolution of Puerto Rico’s wider fiscal problems.

The chances of the legal soundness of Chicago’s Sales Tax Bonds being tested are equivalent to (1) the rating of the City of Chicago, squarely junk Ba1 in Moody’s eyes, and (2) the rating of the State of Illinois, one level above junk, Baa3 on negative watch.   This means that the risk of a realpolitick showdown with respect to Chicago’s sales tax bonds is much closer to a junk bond risk than it is to a AAA risk.

Under current law, neither the City of Chicago nor the State of Illinois has the authority to declare bankruptcy.  However, this may or not work to the benefit of Chicago’s Sales Tax Bonds.  There is no law that can mandate that the State of Illinois and the City of Chicago will always have enough money to pay all of their creditors on time.  And these creditors include City and State employees and pensioners, who will have a great deal of influence over any actions that elected officials decide to pursue with respect to the financial obligations of the City and State.

Prospective purchasers of Chicago’s sales tax bonds might do well to consider their legal finery in light of Chicago’s current record in enforcing criminal law.

According to the Chicago Sun-Times, last year the city tallied 781 murders and only 204 arrests, a 25 percent arrest or ‘clearance’ rate.  This clearance rate has fallen nearly every year since the Chicago Police Department began posting data online in 2006, and current clearance rates are probably at a record low. In the 1970s and ’80s, the department regularly cleared around 80 percent of murders, according to Murder Accountability Project, a nonprofit that tracks clearance rates in cities nationwide using FBI data.

About Chris Donnelly

Christopher J. Donnelly, is an experienced attorney, bond analyst and fixed income strategist, with years of experience in structured finance, distressed bonds and bond related litigation in a variety of industries and the emerging markets. He is a graduate of Rutgers University (BA), The University of Pennsylvania (JD) and New York University, (LLM in Taxation). Chris is a Managing Director of Straacom, LLC and can be contacted at Straacom provides strategic research, analysis and communications for publication and on assignment for private clients.

One comment

  1. Can you rate the franklyn ca. Tax free bonds , are any better they approx 3.2 % this year. I am small time investor can you help?

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