CHICAGO – A Chicago suburb tarnished by a bond default and federal sanctions for misleading bondholders can now add its list of fiscal ills a court finding that its firefighters’ pension fund is near bankruptcy.

An Illinois appellate court on Aug. 4 upheld a trial court decision from 2015 ordering Harvey, an impoverished city south of Chicago, to levy a property tax to meet its firefighter pension fund obligations. The appeals court went a step further and concluded the fund is on the verge of default. It’s a first-of-its-kind finding by an Illinois court.

“The severe fund deficiency and alarming rate of asset depletion, and Harvey’s demonstrated inability to collect on its tax levies to support its obligations establish that the pension fund’s ability to pay the beneficiaries will be extinguished in the near future,” said the ruling from the Appellate Court of Illinois First District.

The trial court had found that Harvey violated state pension statutes and a 1996 settlement agreement that was reached after the pension fund filed suit against the city alleging it had been shortchanged.

The pension fund returned to court in 2012 accusing of the city of violating terms of the agreement on required contributions and asked the court to require the city to levy a tax to meet its obligations.

The pension fund argued that the city had shortchanged it by $10 million from 2005 to 2014 – in some years making no contributions – and that the fund should have held assets of $34 million in 2014 instead of $11.2 million, a number so low as to put the fund on the verge of insolvency.

Harvey countered that the pension fund – which was funded at a 27% ratio in 2014 with $30 million of unfunded liabilities – was not nearing bankruptcy, citing the even weaker ratios among other public safety funds in the state. The city argued the courts could not, in turn, order it to levy a tax.

The trial court sided with the fund and ordered Harvey to pay damages of $15 million and told it to approve a line-item property tax levy for the pension fund so that it could meet “annual actuarial requirements.” The trial court however did not find the fund was on the verge of default or imminent bankruptcy.

Arguments in the appeal process centered on whether the trial court erred in finding violations of the pension code and requiring the city to meet a specified payment obligation without first finding that Harvey was on the verge of default, which under state statutes would allow for the courts to order a tax levy. Arguments also addressed whether the trial court erred in finding that Harvey was not on the verge of default or imminent bankruptcy.

The appellate court affirmed the lower court’s rulings with the exception of also finding the fund to be on the verge of insolvency.

The appellate court looked at the fund’s health, at past Harvey practices on contributions, and actuarial findings that the fund could exhaust assets in as soon as five years.

“To be clear, it is not merely the financial status of the pension fund that leads this court to this finding, and we understand that we are the first court to find in this manner,” the opinion said. “The compounding nature of the situation—including the precarious financial position of the pension fund…the constant declarations by Harvey that it has not contributed to the pension fund’s poor financial condition, and the continued lack of financial responsibility shown by Harvey—has convinced this court that this case is a perfect example of a fund on the verge of default.”

The city did not return requests for comment, including about whether it has filed a notice of appeal or plans to do so.

The pension ruling represents the latest in a series of black marks against the city which is still under sanctions that were part of a settlement with the Securities and Exchange Commission. The firefighters’ pension fund cited the role of former city comptroller Joseph Letke in the bond fiasco as a symptom of the city’s past mismanagement.

The city recently lost control of its water finances and it’s yet to fully make good on defaulted bond payments.

“It’s been coming down the tracks for a while,” said Richard Ciccarone, president of Merritt Research Services LLC. “They’ve been an acute case of an inner ring suburb that’s been affected by a declining tax base.”

The city has closed out the last four years without any cash on hand and being forced to raise taxes is going to be “extremely challenging and unduly burdensome,” Ciccarone said.

The city’s regulatory issues, rocky balance sheet, pension woes, and political squabbles that have led to problems even getting its regular tax levy approved make the city a candidate for a bankruptcy if the state were to add a Chapter 9 provision to state law, Ciccarone said.

The city also would serve as a “good first community,” he said, for a special state assistance authority under legislation being promoted by the Chicago Civic Federation. The authority would be charged with guiding troubled local units of government through their financial difficulties.

With public safety pension funding woes weighing on local governments across the state and a state mandate to reach a 90% funded ratio in the coming decades, other municipalities could face similar rulings down the line.

Early intervention to save a community from blight and intergovernmental cooperation is needed to promote consolidation, shared services and other actions because “getting to these things early is critical,” Ciccarone said.

The city has made good on “most the GO” debt service payments due in November and December of 2015 that it had skipped on a $31 million 2007 issue but it has not made good on a more recent default, an investor said.

The city subsequently missed debt service that was due in December 2016 on the taxable piece of the deal, an investor said. About $3.2 million of the taxable deal matures this coming December and about $5.8 million matures in 2024. The remaining $22 million of the 2007 was tax-exempt.

“And they still won’t pick up the phone when we call,” a representative of a fixed-income investment management firm said.

The tax-exempts have traded recently at 66 cents on the dollar. The bonds were originally rated BBB-minus by Fitch Ratings. The taxable piece most recently traded in the 50 cent range in 2016.

The city, which bears responsibility for investor disclosure, has not posted material event notices about the defaults to the Municipal Securities Rulemaking Board's EMMA site.

The city reported $60 million in debt on its balance sheet in its 2016 audited financial report. The city of 25,282 reported operating on a budget of about $50 million.
The city is again filing audits with the state comptroller’s office after years of failing to comply with a state requirement. Harvey last carried a rating of B from Fitch Ratings on its 2007 issue. Fitch withdrew the rating in November 2010 “due to insufficient information provided.”

In a July 19 ruling, Cook County Circuit Court Judge Kathleen Pantle sided with Chicago’s arguments that Harvey had spent water revenue on non-water related expenses in an alleged violation of a consent decree between the two and of state rules.

Chicago sells water to Harvey and Harvey distributes water to both its residents and businesses and a handful of nearby communities. Chicago first sued Harvey in 2012 arguing the suburb was $26 million in the arrears. A 2015 consent decree required Harvey to make monthly payments while some interest on the balance was forgiven.

The court last month granted Chicago’s request for a receiver to monitor compliance with the consent decree. “It is undisputed that Harvey’s water fund finances are in disarray and are being unlawfully raided by Harvey’s government to pay for non water related expenses,” the ruling said.

The city settled in December 2014 SEC charges that it misled bond investors by diverting proceeds away from projects for which they were intended. The complaint was notable in that it marked the first instance of the SEC getting an emergency court order to halt a pending municipal securities offering.

SEC investigators found that Harvey had diverted about $1.7 million in 2008, 2009 and 2010 offerings to finance a now abandoned hotel and conference center project to cover city operations and other non-qualified expenses. Letke also received about $290,000 in undisclosed payments.

In the settlement, the city agreed, without admitting or denying the SEC's allegations, to hire an independent consultant and audit firm. The city also agreed to a ban on selling municipals for three years unless it used an independent disclosure counsel for offerings.

Mayor Eric Kellogg in May 2016 agreed to pay $10,000 and to never participate in a municipal bond offering again in order to settle charges he helped the city mislead bond investors. A federal judge entered a judgment against Letke in January 2015 that barred him from working on any future bond transactions.

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