Chicago Looks to Tap Into a New Source of Revenue to Improve Pension Funding Levels

In order to boost the funding level of the City of Chicago’s municipal worker pension plan, Mayor Rahm Emanuel last week proposed increasing fees charged to water and sewer customers. The mayor’s plan would increase fees by 30% over the next four years, and the resulting revenue would be used by the city to boost its annual contributions to the pension plan. The plan is one of four pension plans covering city workers, and its current funding level is only 37%. Without increased contributions, pension assets are expected to be depleted within the next 10 years.

Chicago’s general obligation bonds are currently rated Ba1, BBB+ and BBB- by Moody’s, S&P and Fitch, respectively. Each of the ratings has a negative outlook, and they also reflect recent downgrades triggered by the city’s growing pension liabilities, with unfunded liabilities estimated at nearly $34 billion. Investors and rating agencies generally have had a favorable response to the proposal, given that the higher fees would provide a resource for the city to improve the funding level of the pension plan. However, the proposal has met with initial resistance from some Chicago City Council aldermen who would prefer increasing city property taxes or other city taxes rather than raising utility fees to raise funds for pensions. Despite those preferences, the city’s choices for staving off pension fund insolvency are limited. Illinois courts have restricted the city’s ability to cut pension expenditures, and the city has already raised property taxes by over $540 million to improve pension funding for Chicago’s public-safety workers.    

The financial stress faced by the City of Chicago has also impacted the credit ratings of its water and sewer bonds, which experienced their own downgrades when Chicago was downgraded because of their credit links as business enterprises of the city. While increased revenues targeted for pensions may be a credit positive for the city’s GO credit, the revenue diverted from the water and sewer enterprises reduces the operating flexibility of those entities and potentially reduces resources that would otherwise be available to fund capital improvements or deferred maintenance for essential services.  Chicago’s pension dilemma shows that investors must be diligent not only in measuring the direct impact on a municipality’s general obligation bonds, but also in understanding that the impact can spread to otherwise strong and well-protected water, sewer and other types of enterprise debt.

Source:  Bloomberg News, Boston College Center for Retirement Research, Fitch, Moody’s, S&P