The Illinois State Supreme Court upheld a lower court opinion on Thursday, ruling that Chicago’s pension reform provisions violated the Illinois State Constitution. Though the decision was not unexpected, as the court had also invalidated pension reform efforts for the State of Illinois’ pension plans last year, it will impede the city’s efforts to stabilize its underfunded pension plans.
Chicago had devised a plan to stem the tide of growing unfunded pension liabilities, estimated to be in the $20 billion range, not only by increasing employee contributions to the plan and limiting cost of living benefits, but also by increasing its annual contributions as an employer. Without the changes, assets in the affected pension plans were expected to be depleted in as early as 10 years. The reform provisions were approved by 28 of 31 unions representing the pensioners, and legislation to adopt the changes was passed by the Illinois legislature and signed by Illinois’ governor in June 2014. Two of the unions challenged the constitutionality of the reforms in December 2014. In July 2015, a Cook County Circuit Court judge agreed with the unions and struck down the reform provisions, subsequent to a decision in May 2015 by the Illinois State Supreme Court that the legislation adopting pension reforms for the state’s own pension plans was unconstitutional.
In May 2015, Moody’s stunned the muni market by downgrading Chicago’s investment grade rating two notches to a non-investment grade level at Ba1. Although the circuit court had not yet opined on the validity of Chicago’s pension plan at that time, Moody’s cited concerns that the Illinois Supreme Court decision would impair the city’s ability to limit its growing pension liabilities. Moody’s current Chicago GO rating is Ba1 with a negative outlook, but S&P and Fitch have still assigned BBB+ investment grade ratings to the GO, both of whom cite pension issues in their negative outlooks.
Chicago’s ability to maintain its current ratings in light of the Illinois High Court decision will depend on how city government responds to the latest setback. One key to implementing a plan will be the city’s continued willingness to increase pension contributions as legislators search for a way to control expanding pension costs that will satisfy state court interpretations of the Illinois constitution. We have written many times over the past few years on the impact that unfunded pension liabilities are having on municipal credit quality. By design, we have avoided state and local governments with poor funding ratios, which is why we have no exposure to the City of Chicago bonds in our portfolios.
Sources: Bloomberg News, Moody’s, Standard & Poor’s, Fitch Ratings