S&P Ex­plains Itelf on Di­verg­ing Sales Tax Rat­ings Within Illi­nois

The Bond Buyer - - Front Page - By yvette ShieldS

CHICAGO – It’s all about the un­der­ly­ing struc­tural fea­tures of the bonds.

That’s what S&P Global Rat­ings says in a re­port ex­plain­ing why Illi­nois’ sales-tax backed paper took a more pun­ish­ing hit than Chicago’s se­cu­ri­ti­za­tion bonds after the rat­ing agency re­vised its cri­te­ria for pri­or­ity-lien tax rev­enue cred­its.

Chicago’s sales tax se­cu­ri­ti­za­tion bonds sold through its Sales Tax Se­cu­ri­ti­za­tion Corp. sunk just one notch to AA-mi­nus, with a rat­ing capped by the new cri­te­ria to four notches above Chicago’s BBB-plus general obli­ga­tion rat­ing.

The state’s Build Illi­nois bonds took a five-notch down­grade BBB, only one notch above the state’s BBB-mi­nus GO rat­ing.

The rat­ing ac­tions – on Oct. 23 for the city and Oct. 30 for the state – fol­lowed the re­vised cri­te­ria pub­lished by S&P on Oct. 22 that link pri­or­ity-lien bonds to the rat­ings of their spon­sor­ing govern­ment.

“While both rat­ings are con­strained by the GO rat­ing of their re­spec­tive oblig­ors, the dif­fer­ence be­tween the num­ber of notches the pri­or­ity rat­ing can rise above the GO is based

on the struc­ture of the bonds,” said the re­port au­thored by lead Chicago an­a­lyst Carol Spain and lead Illi­nois an­a­lyst Gabriel Petek.

The ra­tio­nale be­hind the over­all change in the cri­te­ria is driven by the rat­ing agency’s be­lief that an is­suer’s general credit pro­file may sug­gest a di­min­ished ca­pac­ity to make all pay­ments, in­clud­ing debt ser­vice, even in sit­u­a­tions where pledged rev­enues fea­ture a statu­tory or con­trac­tual lien or are su­pe­rior to other claims.

“Our pri­or­ity lien rat­ings fac­tor in the fun­da­men­tal credit qual­ity of the obligor, not solely the rev­enue stream pledged to the bonds,” S&P wrote.

S&P has 1,300 rat­ings that fall un­der the re­vised cri­te­ria and test­ing sug­gests that 15%-25% of the rat­ings would not change, 40%-50% would rise or fall one notch, 15%-25% two notches, and 10%-20% three or more notches, with the ma­jor­ity of these changes lim­ited to three notches.

The rat­ing agency moved quickly on the Chicago and Illi­nois rat­ings be­cause both had deals in the works.

Un­der the new cri­te­ria, pri­or­ity lien rat­ings are capped at four notches above the obligor but the notch dis­tinc­tion is based on a re­view of the un­der­ly­ing strength of the tax lien bonds struc­ture and in­su­la­tion from its obligor op­er­at­ing risks.

Both the Build Illi­nois bonds – a more tra­di­tional sales tax rev­enue bond struc­ture – and the se­cu­ri­ti­za­tion – a true sale of pledged rev­enues to a bank­ruptcy-re­mote spe­cial en­tity – en­joy strong debt ser­vice cov­er­age ra­tios, a broad tax base, low volatil­ity in col­lec­tions, and would war­rant higher un­der­ly­ing rat­ings, S&P said.

The Build Illi­nois bonds are only one notch above Illi­nois GOs be­cause there’s no lock­box on the rev­enues or “mean­ing­ful” lim­i­ta­tion on the use of rev­enues.

“Fi­nally, the is­suer is a state—in this case, Illi­nois—which re­tains ul­ti­mate dis­cre­tion over the al­lo­ca­tion of its tax rev­enues,” S&P wrote.

An­a­lysts don’t ex­pect the state to di­vert pledged rev­enues in vi­o­la­tion of its own laws should its liq­uid­ity strains es­ca­late, but the state’s past vi­o­la­tions when it de­layed pen­sion pay­ments give them pause.

“This, in our opin­ion, sup­ports the view that Illi­nois could pos­si­bly de­lay or re­duce pay­ments,” the S&P an­a­lysts wrote.

The le­gal en­hance­ments of the STSC bonds al­lowed for the four-notch rat­ing above Chicago’s — the high­est pos­si­ble un­der S&P’s new cri­te­ria — be­cause they pro­vide ad­di­tional pro­tec­tions against the city’s own op­er­a­tion and bud­get strains.

Char­ac­ter­is­tics that can war­rant the wider notch dis­tinc­tion in­clude cases where rev­enues are nei­ther legally nor prac­ti­cally avail­able for op­er­a­tions, in­clude a sale or trans­fer or rev­enues to a lim­ited-pur­pose en­tity au­tho­rized by state law, pledged rev­enues’ con­trol is in­de­pen­dent of the obligor’s, the is­suer is a lim­ited-pur­pose en­tity, and a le­gal opin­ion ex­ists that pledged rev­enue would not be con­sid­ered part of the obligor’s es­tate in a bank­ruptcy.

Those fea­tures are built into the state’s 2017 leg­is­la­tion that au­tho­rized the se­cu­ri­ti­za­tion bonds for home rule units and the city’s or­di­nance. The pledged rev­enues also flow di­rectly from the state to the cor­po­ra­tion or its trustee.

S&P con­sid­ered link­ing the STSC rat­ing to the state be­cause Illi­nois col­lects and dis­trib­utes the pledged rev­enue but in the end the agency’s an­a­lysts con­cluded the like­li­hood the state would in­ter­fere with home rule sales taxes is re­mote.

IHS Markit said it ob­served a 35 ba­sis point widen­ing of Build Illi­nois spreads on a 2032 ma­tu­rity Fri­day com­pared to trad­ing lev­els prior to the down­grade. ◽

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