Fitch Affirms Chicago, IL Sales Tax Bonds 'AA-'; Outlook Stable

Fitch Ratings has affirmed its ratings on the following debt issued by the city of Chicago:

$113.2 million sales tax revenue refunding bonds, variable rate series 2002 (adjusted SIFMA rate) at 'AA-'.

The series 2002 bonds were initially issued in the weekly mode, and in 2008 were converted to the daily mode. The interest mode is now being converted to the adjusted SIFMA rate mode. On the reoffering date (estimated for Feb. 16, 2012) the bonds will be subject to mandatory tender and the existing standby bond purchase agreement will be cancelled after the bonds are remarketed. The rate will be adjusted weekly and has a maximum of 15%. The bonds will be subject to mandatory tender with a targeted date of Jan. 1, 2015, and are callable by the city six months prior to the tender date. During the SIFMA rate mode, bondholders will not have optional tender rights. The bonds mature Jan. 1, 2034.

At this time, Fitch also affirms its rating on the other approximately $464 million in outstanding sales tax revenue bonds at 'AA-'.

The Rating Outlook is Stable.

SECURITY

The sales tax bonds have a first lien on the city's home rule sales and use tax of 1.25% and the city's local share of state distributed 6.25% sales and use tax.

KEY RATING DRIVERS

CHANGE IN RATE MODE: Fitch views the conversion to an adjusted SIFMA rate from a daily mode and cancellation of the standby bond purchase agreement as credit-neutral. Since bondholders do not have the option to tender bonds prior to the mandatory redemption date, Fitch believes the city will have ample time to prepare for the bonds' redemption or the conversion to another mode.

STRONG REVENUE BOND PROTECTIONS: Debt service coverage from sales tax revenues is expected to exceed a high 12 times (x) based on maximum annual debt service (MADS) of all sales tax revenue bonds including the series 2002 bonds. Issuance of additional bonds requires at least 5x MADS coverage. A springing debt service reserve, to be funded over a 12-month period, would be triggered if coverage falls below 2.5x. The rating on these bonds is capped at the equivalent of the unlimited tax GO rating. Fitch therefore believes that the city's overall credit profile is important to its analysis of the sales tax bonds.

RETIREMENT BENEFIT RISKS: Fitch views positively concerted efforts towards pension reform but is concerned about the magnitude of unfunded liabilities and the potential for significant legal, policy, and practical challenges to achieving this goal.

BUDGET IMBALANCE BEING ADDRESSED: The current management team has made significant progress in implementing measures to address a large budget imbalance with primarily recurring funding sources rather than use of reserves and other non-recurring measures.

BROAD BUT FALTERING ECONOMY: Economic indicators have been weak and state-wide forecasts indicate continuation of this trend. Despite this weakness Chicago remains an important commercial and trade center with good prospects for long-term stability if not growth.

SOLID RESERVES REMAIN: Despite the use of a large amount of available reserves to fund budget gaps in the last three years, the city retains significant balances in reserve funds which the current administration intends to preserve.

SIZABLE DEBT BURDEN: Debt levels are above average, in part because of the city's historical practice of using bond proceeds for legal settlements and retroactive salary and pension payments in addition to capital needs. Fitch believes the debt burden will remain above average given recent tax base erosion, increasing debt service, and capital needs of overlapping entities.

CREDIT PROFILE

Chicago has a broad, diverse economy that experienced significant recessionary weakness from which it is struggling to recover. This softness has affected financial operations, as several of the city's varied revenue sources have underperformed expectations. For the past few years revenue shortfalls were offset primarily with use of non-recurring funding sources, including reserves resulting from proceeds of long-term asset leases, and only modest adjustments to spending.

The current administration came into office in May 2011 and is highly focused on reversing this trend and achieving structural budget balance. Fitch views this positively, while believing the city's ability to implement ambitious changes is likely to face significant challenges from those affected by the changes, particularly labor unions. The city reports that about 90% of workers are members of a union.

Sales Tax Revenue Bond Coverage

Debt service coverage on sales tax revenue bonds is expected to continue to be very strong and well-protected by a restrictive additional bonds test (ABT) that requires 5.0x MADS coverage. The high coverage level somewhat offsets Fitch's concerns about the exposure of potential swap termination payments in the future if swaptions are exercised and the city subsequently chooses to terminate them.

A small portion of pledged revenue from the state's local share sales tax is subject to annual appropriation by the state. Since this portion has historically been less than 10% of pledged revenue Fitch does not believe a delay in or failure to appropriate would result in a significant impairment of credit quality. Indenture provisions include a covenant by the city to take any legal action to insure that pledged sales taxes produce coverage of at least 1x of all senior and any subordinate debt service. Fitch believes the need to invoke this covenant is unlikely (given the coverage and ABT) and practical considerations would make implementation difficult given the already high sales tax rate and likely resistance to further increases.

Financial Operations

The city ended 2010 with an operating surplus and an unreserved general fund balance of 2.7% of spending, an improvement from the past few years. The surplus was the result of positive variances in both revenues and expenditures from budgeted expectations. However, the positive fund balance position relied on transfers in from reserves equal to about 15% of total funding sources. Including remaining reserves, primarily from proceeds of the long-term lease of the Chicago Skyway, the 2010 ending unreserved general fund balance would be 30.5% of spending. 2011 marks the third year that relies heavily on use of reserves, although the amount is down to about 10% of budgeted revenue. Using the city's estimate of spending and assumption of break-even results for 2011, the comparable unreserved balance at year-end would be 19% of spending.

Fitch views positively the city council's unanimous vote to adopt the 2012 budget. The budget closes a $635 million gap with over $500 million in recurring actions and a much reduced use of non-recurring items. The budget also commits to returning $20 million to long-term reserves. Corporate (general) fund spending falls by 5.1%. Structural measures include competitive bidding for a number of city services, reorganizing and consolidating public safety headquarters, reconfiguring trash collection, and instituting a wellness initiative.

These changes will result in over 500 layoffs and the elimination of approximately 2,100 budgeted vacant positions. Targeted revenue increases include eliminating waivers for some fees, increasing fines, raising the hotel tax, instituting a congestion premium on parking, and improving revenue collections. The budget uses $88 million in debt restructuring and other financing initiatives, but otherwise limits non-recurring funding sources into the corporate fund.

Long-Term Liabilities

The size and direction of long-term liabilities is a significant rating concern. Three of the city's four pension plans are less than 50% funded as of December 31, 2010, using Fitch's 7% discount rate assumption. In aggregate the unfunded liability equals a high 5.2% of market value. The city is required to make a statutory payment based on a multiple of payroll, which is funded from dedicated tax levies for each plan and reported in special revenue funds rather than the general fund.

Although the statutory payment is consistently funded it is in all four cases less than one-half the actuarially required contribution (ARC), and in three is less than 40%. State legislation enacted in January 2011 reduces benefits for new employees, but requires the public safety plans to be 90% funded by 2040. The city estimates that this would require an increase of approximately $550 million per year starting in 2015, more than doubling the current contribution for all four plans.

The city is working toward pension reform to relieve the severe underfunding and alleviate the need for a significant tax increase starting in 2015. Fitch views positively the city's focus on this critical issue but believes that reform of the magnitude needed to significantly improve funding levels will be difficult to achieve. The city may have a liability for post-employment benefits beyond the expiration of a current settlement agreement on June 30, 2013.

In addition to the large pension liabilities, debt ratios are high and increasing. Overall debt is 6.0% of market value or $6,280 per capita. In addition to funding capital, the city has in the past bonded out payments for retroactive salary and pension settlements. Management expects to discontinue the latter practice, which Fitch views positively. Debt amortization is below average at 33% in ten years. The tax base is on a declining trend which Fitch believes will continue in the near term given weak real estate data. This combination will keep the debt burden elevated even if issuance is curtailed.

Economy

Chicago's 2010 census population was 2.7 million, down 5% from the 2000 census. The state's economy is centered here, as the Chicago-Joliet-Naperville metropolitan area comprises nearly three-quarters of the state's population. As in much of the country, the economy has gradually shifted away from manufacturing, and the activity in that sector that remains is more resilient than the traditional durable goods emphasis.

Although Chicago continues to attract businesses and jobs to some extent, it faces significant economic challenges. The weak regional residential real estate market is evidenced by anemic housing starts and continued year-over-year declines in home prices through the second quarter of 2011. The city's unemployment rate remains high at 11.2% in November 2011, up from 10.1% in November 2010 despite a 1.4% decline in the labor force. Regional job losses since 2007 total 6.3% and have occurred in every sector except educational and health services. November 2011 figures show total number of jobs in the region up 0.7% from November 2010. Income indicators are close to state and national averages, although the individual poverty rate, at 20.8% in 2009, is notably above both.

Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

In addition to the sources of information identified in the Tax-Supported Rating Criteria, this action was additionally informed by information from Creditscope, University Financial Associates, S&P/Case-Shiller Home Price Index, and IHS Global Insight.

Applicable Criteria and Related Research:

--'Tax-Supported Rating Criteria' (Aug. 15, 2011);

--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 15, 2011).

Applicable Criteria and Related Research:

Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648898

U.S. Local Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648842

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