Exclusive: Chicago rating downgrade may end swaps deals - Moody's

CHICAGO (Reuters) - The downgrade of Chicago's credit rating by Moody's Investors Service on Friday could immediately terminate four interest-rate swap agreements, costing the city about $58 million, and could lead to more terminations in the city's swaps portfolio.

Moody's in a report noted that its downgrade of Chicago's credit rating to Baa2 triggered termination clauses in four swaps contracts, used by Chicago to hedge interest-rate risk on its variable-rate bonds. Chicago will be required to pay $58 million penalties if it cannot reach settlement agreements with counterparties on the four swaps contracts, Moody's noted.

Moody's also noted that the downgrade to Baa2, two notches above the junk level, moves the city closer to termination of 11 more swaps deals. Termination on those contracts would potentially cost the City of Chicago an additional $133 million, Moody's noted.

Chicago, the third-biggest U.S. city, has the financial resources at hand to cover the initial termination payments, Moody's said.

"The city's available liquidity is more than sufficient to cover these termination costs," Moody's stated in its report on the credit downgrade.

If the rating falls below Baa2, Chicago could be forced to pay about $1.2 billion if banks that provide liquidity facilities like letters of credit for city debt demand immediate collateral, Moody's said. Chicago's operating budget totals $3.53 billion.

In its downgrade report, Moody's said Chicago's rating could fall further if Illinois courts find pension reform laws enacted to shore up the state's financially ailing pension system and for two of Chicago's retirement systems are unconstitutional. A ruling by the Illinois Supreme Court on one of the laws could come as early as this spring.

Another major credit rating agency, Standard & Poor's, warned Friday Chicago could face a multi-notch downgrade of its A-plus rating if it fails to come up with a sustainable plan this year to pay its escalating pension contributions. That would also put Chicago closer to triggering the end of swap deals.

In an affidavit late last year, the city's chief financial officer, Lois Scott, acknowledged that a single-step downgrade by either Moody's or S&P could trigger about $50 million in immediate payments and expose the city to variations in interest rates.

A spokeswoman for Chicago Mayor Rahm Emanuel did not immediately respond to a request for comment.

The downgrade and violation of terms on the swaps agreement likely will become an issue in Emanuel's re-election campaign. The first-term mayor, a former chief of staff to President Barack Obama, failed on Tuesday to win a majority of votes in a primary election, and faces a runoff vote April 7 against a Cook County commissioner, Jesus "Chuy" Garcia.

Moody's based its one-notch downgrade to Baa2 with a negative outlook on the city's growing costs related to its big unfunded pension liability. It also warned the rating could fall further should Illinois courts void cost-saving pension reforms on constitutional grounds.

Chicago is defending a 2014 Illinois law that boosted pension contributions by the city and its workers to two of its retirement funds and reduced benefits. In the affidavit and in testimony earlier this month in Cook County Circuit Court, Chicago CFO Scott quantified the city's exposure to a variety of credit instruments as a result of further rating downgrades.

Under a three-notch downgrade, Chicago would default on about $2.8 billion of credit facilities, including letters of credit, that the city would likely not be able to replace, according to Scott. City documents showed Chicago had about $2.6 billion of GO and revenue bonds tied to interest-rate swaps as of end of September.

The city, under Mayor Rahm Emanuel, has eliminated hundreds of millions of dollars in risk by terminating or renegotiating 18 interest rate swap or swaption contracts and those efforts are continuing, spokeswoman Libby Langsdorf said last month.

Shawn O'Leary, a senior research analyst at Nuveen Investments, said banks tend to renegotiate terms on swap agreements.

"I would be surprised if the parties demand termination payments," he said.

(Reporting by Karen Pierog; editing by Phil Berlowitz, David Greising and Bernard Orr)