CHICAGO – Chicago's second shot at fixing one of its woefully underfunded pension funds offers investors at least a small sign of progress, several market participants said Tuesday.
The plan – announced by Chicago Mayor Rahm Emanuel's administration Monday – has challenges.
It must be approved by state lawmakers and the governor, is short on actuarial detail, and would take decades to reach a healthy funding level. Most notably, it offers a solution only for the much smaller of the two funds, market participants cautioned.
Still, it represents progress in the right direction.
"The investment market likes seeing positive motion so Chicago needs to show that it is making progress in addressing these huge pension gaps," said Richard Ciccarone, president of Merritt Research Services LLC.
The new proposal for the laborers' pension fund does that, he said. "It's not perfect, but the city has to start somewhere and they are looking for something positive they can share with investors," Ciccarone said.
"Obviously, it's a positive step but a lot of hurdles remain," said Lyle Fitterer, senior portfolio manager at Wells Capital Management. "Are they going to get legislative approval?" he asked. It remains to be seen if Chicago can apply the same the fix to the larger municipal employees' fund, he said.
Fitterer said he saw a slight tightening of city spreads, but "there was no meaningful movement in terms of price action."
Some trade data showed a 10 basis point tightening on some city general obligation paper. Markit said it saw little meaningful trade changes.
Progress on the pension front also could be overshadowed by the state's ongoing budget impasse and the Chicago Public Schools' funding crisis because "those issues all impact where Chicago trades," Fitterer said.
The plan calls for Chicago to raise its contributions to the laborers' pension fund by at least 30% annually over the next five years to reach an actuarially based payment. The laborers' revenue fix comes at the expense of the municipal employees' pension fund, for which no solution has been agreed to.
An additional $40 million of annual revenue generated by a 2014 telephone fee surcharge enacted to help pay for higher payments to both funds under a failed 2014 reform package will now go solely to the laborers' fund.
The city currently pays about $15 million annually to the laborers' fund, far short of the $117 million needed under an actuarially based formula, according to fund documents.
"We think the market will see the news as progress – after all, any sign that the city and its labor units have been able to agree to a framework that appears able to pass court scrutiny is a good thing," said Tom Schuette, co-head of credit research and portfolio management at Gurtin Fixed Income Management. "However, this is merely the first pitch in what is going to be a long game. The city still obviously has work to do with its other pension plans, and agreeing to a plan is one thing, being able to fully fund the agreed upon contributions is another."
Laborers' plan employees starting in 2017 would also contribute more under the agreement struck with unions. Current tier two employees who started after 2010 could shave two years off their retirement age if they agree to contribute more. Retirees and employees hired before 2011 face no changes.
The plan would put the funds on course to reach a 90% funded level by 2057, its supporters say.
Ciccarone said the decades-long approach, which is similar to the 2014 reform plan that failed a state Supreme Court review, combined with the city’s proposed re-amortization of its public safety funds, is worrisome because it defers truly tackling the obligation. At the same time, Ciccarone said he’s cognizant of the city’s need to keep a fix affordable.
The laborers' fund, which serves about 8,000 members, is on course to deplete assets in 2027. Unfunded obligations rose to $1.2 billion in 2015 from $754 million in 2014 with its funded ratio falling to 53% from 64.3%.
The proposed plan would require state legislative approval but the city does not believe it would face the same legal obstacles that doomed its 2014 pension reform package. The Illinois Supreme Court voided the pension changes in March because cuts to employee and retiree benefits violated the state constitution's pension protection clause. The new plan has no direct cuts.
"It's hard to evaluate at this point. The devil is in the details and the things that can trip you up aren't seen until they are in print," Clint Krislov, of Krislov Law, said of the plan's legal prospects. Krislov represented a group of plaintiffs behind the successful effort to overturn the 2014 reforms.
Krislov said he'd prefer to see a more sweeping solution to the city's pension woes, instead of a piecemeal approach. "Chipping away sows the seeds of distrust and concern," he said.
Rating agencies and investors have been pressing the city to announce an alternative plan since the state Supreme Court overturned the earlier pension overhaul. A bigger hurdle for the city now lies in stabilizing the larger municipal employees' fund given the more significant infusion of revenue that will be needed.
The city is in negotiations with the roughly 30 unions who represent its general municipal employees and city finance officials said they believe the laborers' agreement offers a good framework for discussions.
The two funds account for half of the city's roughly $20 billion unfunded pension tab, which has dragged its general obligation rating down into junk bond territory, with the threat looming of further deterioration absent a viable plan to solve its pension crisis.
The city's GOs are rated Ba1 by Moody's Investors Service and BBB-plus by Kroll Bond Rating Agency and S&P Global Ratings. Fitch Ratings has the city at the lowest investment grade level of BBB-minus.
The city currently pays $162 million annually toward the municipal employees' fund, a contribution level that like its other funds is based on a statutory formula that represents a percentage of employee contributions. It falls hundreds of millions of dollars short of what an actuarially required contribution would be. The municipal fund, which has about 70,000 members, is headed toward insolvency in 2025. Its unfunded liabilities grew to $9.8 billion in 2015 from $7.3 billion in 2014 and the funded ratio fell to 32.9% from 40.9%.
Legislative uncertainties abound. Chicago’s chief financial officer Carole Brown and budget director Alexandra Holt said the city intends to present the laborers' fund legislation to the General Assembly for its annual fall veto session.
The fate of Emanuel's proposed re-amortization of the city's public safety contribution schedule remains unclear. Legislation shaving $220 million of the city's annual payment is sitting on Gov. Bruce Rauner's desk. He has threatened to veto it unless Emanuel helps persuade his fellow Democrats to agree to policy and governance reforms.
