GO rating fallout over event defaults on unrated bonds draws market scrutiny

S&P Global Ratings’ seven-notch downgrade of a Chicago suburb’s full faith and credit pledge over default events on unrated revenue bonds casts a spotlight on management and governance factors and the risks they pose to the value of general obligation bonds.

The issue has captured the attention of market participants with Fitch Ratings, which does not rate the village in question, explaining how it would view the situation and Municipal Market Analytics opining on the action’s impact.

“We generally do not expect payment trouble on nonrecourse debt to extend to the general credit rating, and we don’t think we are in the minority in holding that view,” Municipal Market Analytics said in its weekly outlook report distributed Tuesday.

Bolingbrook’s failure to avert five sinking fund defaults on $47.7 million of nonrecourse sales tax-backed bonds issued in 2005 for a retail development and lack of a plan to avert a future payment default prompted S&P’s rebuke in a Jan. 26 report cutting the rating to BBB-minus from AA.

“The likelihood of default upon the term bonds’ maturity results in a weaker management assessment for the village under our criteria,” S&P analyst Andrew Truckenmiller said. “As a result of the weaker management score, our rating on the village’s GO debt is capped” at BBB-minus. The village has $200 million of direct debt. The outlook on the GOs is stable.

The village of 73,000 southwest of Chicago fired back, warning the downgrade sets “a harmful and disruptive precedent for any credit secured by specific revenues that do not pledge the taxing power of the related municipality.”

While one holder of the unrated bonds believes such ratings accountability is warranted, the role of management and governance in such a sharp rating action has prompted questions among market participants over the risks posed by such non-GO credits to the value of GOs held by investors.

“It seems from the agency’s published research and analysts’ responses that the investigation into the default on the unrated, nonrecourse debt of the rated issuer may have uncovered broader governance concerns that contributed to the aggressive rating downgrade,” wrote Matt Fabian, partner, and Lisa Washburn, chief credit officer, authors of the MMA commentary.  

“In other words, the outcome may be the result of a combination of factors and the facts and circumstances related to the specific situation rather than a reflexive response to the missed payment,” MMA said. “And while S&P has indicated to us that this is a fair interpretation of the rationale behind the rating action, if it were not, it could mark a shift in the treatment of the relationship between GO and nonrecourse debt, compelling investors to consider the impact of the latter when evaluating a GO credit for purchase.”

MMA noted S&P raised concerns over the late disclosure of the five sinking fund defaults, lack of transparency regarding the debt, which was not reflected in the audit, a decision to not support the bonds after supporting debt service payments between 2017-19, and the failure to craft a solution to avert a future default, as well as other weak financial practices.

Fitch weighed in Friday, publishing a special commentary that explained the “meaningful difference” in its rating approach in such a situation involving GO and issuer default ratings.

The village’s “recent default on a series of nonrecourse sales tax revenue bonds backed by a narrow area of its tax base would not affect Fitch Ratings’ view of the municipality’s overall credit quality,” Fitch wrote in “Bolingbrook (IL) Rating Actions Point to Analytical Differences.”

Fitch does not rate the village’s GOs or sales tax bonds. “We received a few calls from investors regarding this rating action and felt like it was important to clarify the difference in our approach,” Fitch analyst Karen Ribble, a senior director, said in an email.

Fitch’s ratings definitions state that IDRs opine on an entity’s relative vulnerability to default on financial obligations whose non-payment would best reflect the uncured failure of the entity, and a default of nonrecourse bonds does not meet that criteria. 

“A default on a dedicated-tax bond that does not have any recourse to the issuer’s general revenues would not trigger negative rating action on the issuer’s IDR because it does not reflect the issuer’s general credit quality or willingness to pay its financial obligations,” Fitch said.

Fitch generally caps the ratings of local government dedicated-tax bonds at the IDR because it believes such pledges are unlikely to survive the filing of a bankruptcy by the municipality absent legal protections, such as a statutory lien.

Fitch also highlighted the offering statement’s language on the limited pledge of the sales tax from the retail district, the lack of a direct village obligation, and warning that the bonds represented a “high degree of risk.”

Bolingbrook published its initial response to the S&P action as a voluntary disclosure on the Municipal Securities Rulemaking Board’s EMMA website.

“The village believes S&P’s rating action attempts to cause a de facto conversion of the Series 2005 bonds to a general obligation of the village by force of its downgrade,” the statement read. “The village believes this is a misapplication of its rating criteria and further sets a harmful and disruptive precedent for any credit secured by specific revenues that do not pledge the taxing power of the related municipality.”

S&P declined to comment on Fitch’s commentary and referred to its published rating action when asked to comment specifically on whether the event defaults alone would have triggered the rating cap.

The bonds were issued to help finance a retail center anchored by a Bass Pro Shops, Meijer, and a Macy’s, as part of a sales tax district that included an already operating Ikea store, the offering memorandum said.

The bonds are secured by sales tax revenues in a specially designated area for a retail development project. The missed sinking fund deposits that began in 2020 were disclosed in October by the bond trustee and triggered an event of default under the bond indenture.

The village government told S&P that pledged revenues will likely fall short of meeting both the 2024 and 2026 term maturities and the village lacks a formalized plan to use other available resources to satisfy the debt service obligations.

S&P’s local government GO rating methodology, which has been in place since 2013, guided the action and has resulted in similar actions on other GO credits, analysts said in an interview after the downgrade. Environmental, social, and governance credit factors for the change fall under “risk management, culture, and oversight.”

Pledged revenues have fallen short of projections needed to meet debt service demands and reserves have been exhausted, leading to a shortage of approximately $2.6 million, according to S&P. About $20 million remains outstanding.

The village holds a healthy general fund balance of $50 million, which is equal to 64% of revenues, so “the village’s lack of action to support the 2005 sales tax revenue bonds reflects an unwillingness, not an inability, to pay debt service on time and in full,” S&P said.

S&P said Bolingbrook’s rating may be downgraded to junk if debt service is not paid in full on the sales tax revenue bonds or if the fallout from the potential 2024 term bond default pressures the village’s operations, budgetary flexibility, or liquidity profile. S&P could lift the BBB-minus cap if officials demonstrate a willingness to pay all debt service requirements in full and on time.

Many of Bolingbrook’s GO issues carry insurance from Assured Guaranty.

One holder of the bonds contacted The Bond Buyer to voice frustration over what it reports as a lack of information from the village over the amount of sales taxes being collected in the designated district.

The investor, who asked the fund’s name not be used, also questioned the lack of disclosure on the bonds and sinking fund defaults in past city audited financial statements and lack of timely disclosure on EMMA.

“Nearly two years went by before any documents were posted to EMMA. We still have no idea what collections have been,” the investor said. While the unrated bonds represented a risky investment that the village has noted went to “sophisticated investors,” the investor said there are retail mom-and-pop holders not just big institutions.

“We represent individual clients who invest some of their life savings through us which are partially allocated to these bonds,” the investor said. “The village’s indifference to creditors is wholly unacceptable and raises questions about mismanagement, if not possible fraud.”

“Simply letting the bonds default like a banana republic, when they could easily be restructured, is not what investors expect from a AA issuer,” the investor said. “This creates dangerous moral hazard whereby issuers are incentivized to let bonds default so they can sooner claim future tax payments from a project.”

Asked about questions raised by the investor, village Finance Director Rosa Cojulun said in an email Tuesday, “the issues surrounding the S&P action are evolving. If or when the village communicates additional information, it will do so via EMMA.”

Moody’s Investors Service affirmed the village’s A2 underlying rating in November in conjunction with the implementation of its U.S. Cities and Counties Methodology published on Nov. 2 that reflects cities and counties’ ability to repay debt and debt-like obligations without consideration of any pledge, security, or structural features. Moody’s downgraded the village by one notch in 2016 at which time it had $316.9 million in GO debt outstanding.

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