CHICAGO — Chicago may have chipped away at its structural budget gap this year, but fiscal stress looms in the coming years as debt service and pension costs rise along with health care and other personnel costs.

The city laid out its challenges in its annual financial analysis, which presents an overview of revenues and spending, as well as an examination of key fiscal areas such as reserve funds, capital investments, tax-increment financing, debt load and pension funding.

Along with a current snapshot, the analysis also offers a retrospective and a three-year fiscal forecast based on scenarios that range from negative to positive revenue growth.

While making headway by adopting structural changes in the form of cuts, management efficiencies and fee increases, Chicago needs additional reforms to its spending habits and pension system to avoid a deterioration of its balance sheet, the analysis says.

The city must close a $369 million deficit in next year's budget, which equals 11.5% of its corporate general fund expenditures. The analysis warns that a $466 million deficit looms in 2014 and a $580 million one in 2015 based on a mid-level financial forecast.

"Even under optimistic projections, the city will continue to experience a sizable annual budget shortfall for several years," the report warns. "The persistent existence of a substantial corporate fund gap makes clear that many of the challenges underlying the structural deficit remain, as the city continues down the road to true fiscal sustainability."

Mayor Rahm Emanuel, who ordered the annual analysis soon after he took office last year, faces a tricky balance in how the city portrays its fiscal situation as it seeks to promote its economic strengths to lure business while convincing investors of an improving credit situation.

Emanuel also wants to show the public he has made strides, but at the same time he needs to persuade Illinois lawmakers that the city cannot afford inaction on pension reforms.

Personnel costs consume 85% of the city's corporate general fund budget. About three-quarters of personnel costs fund public safety employees. The city workforce overall is down by 20% to 32,300 this year from 40,500 positions in 2003. The average annual employee cost has risen to $96,000 last year from $58,000 in 2003.

Reflecting national trends, the city's health care costs have risen steadily to $405 million in 2010 from $310 million in 2003. Between 2003 and 2011, city workers' compensation costs skyrocketed from $58.4 million to $114.5 million.

Chicago cut spending and positions, raised fees and restructured some debt in the $6.3 billion 2012 budget to help eliminate what originally was estimated at a $741 million preliminary deficit.

The city expects total corporate fund revenues this year of about $3.12 billion, including about $143.5 million carried over from an ending balance in 2011. The corporate fund is part of the larger overall budget. It projects an ending balance in 2012 of $33 million. In looking forward to 2013, Chicago anticipates a 9% decrease in its corporate fund to $2.83 billion.

The corporate fund forecasts don't directly take into account rising debt service obligations and pension costs, which are funded with property taxes that don't flow to the corporate fund.

Chicago's $467 million scheduled pension payment in 2014 will leap to $1.2 billion in 2015 due to state-mandated increases for the city's fire and police funds. In order to cover these contribution requirements, the city would need to either drastically reduce core services, or increase its property tax levy.

Emanuel is pushing for a state overhaul of city pensions that would reform both funding and benefits, but its fate is uncertain. Chicago is carrying total unfunded liabilities of $17 billion across its four pension funds, and that is expected to rise to $25 billion by 2017 without action. Two of the four funds are headed to insolvency in the mid to late 2020s.

Chicago's general obligation and revenue-backed debt load hit a high of $20.2 billion in 2012. Its debt has not only funded capital projects, but also retroactive personnel raises and settlements and judgments. Total debt service will rise to $1.55 billion next year from $1.3 billion in 2012, including a jump to $511 million on property tax-supported GO debt from $386 million this year.

"Even if no new long-term debt is issued, and assuming no refinancings, the city's debt service payments will continue to increase through 2015," the report warns.

Chicago's capital budget totals $7.7 billion over the next five years, with about $5.5 billion funded through borrowing and $1.3 billion from federal aid. About 56% of borrowing will come from water- and sewer fee-backed bonding and another 31% from proceeds of airport-related debt, according to the report.

At the close of 2011, Chicago retained a $500 million reserve set up with proceeds of its $1.8 billion 2005 Skyway toll bridge lease and $123 million remains in reserves set up with proceeds of the city's controversial $1.15 billion 2009 lease of its parking meter system. Former Mayor Richard Daley used much of the parking lease proceeds to balance budgets. The city deposited $20 million back into the funds in 2012.

Fitch Ratings recently affirmed Chicago's AA-minus rating and stable outlook. Standard & Poor's affirmed its A-plus rating and stable outlook. Moody's Investors Service this year revised its outlook to negative on Chicago's $8 billion of Aa3-rated GO debt.

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.