CHICAGO – Chicago Mayor Rahm Emanuel’s administration said the state inaction on pension reform caused Fitch Ratings to put the city’s ratings on negative watch.

Fitch took the action Wednesday on the city’s AA-minus ratings, attributing it to growing concern over the near- and long-term risks of the city’s unfunded liabilities that overshadow other improvements in the city’s credit profile such as moving its budget closer to structural balance.

Fitch’s decision impacts $8 billion of GO debt, $500 million of sales tax-backed bonds, and $200 million of commercial paper. The city faces a potential downgrade in six months absent action at the state level or through a city developed strategy to address its growing pension obligations.

“Lack of meaningful solutions to both the near and long-term problems presented by the poorly funded systems would lead to a downgrade of the ratings,” Fitch wrote.

“As Mayor Emanuel has said repeatedly, the pension problem didn’t happen overnight and now it is at our door step,” a city statement said. “If Springfield does not make necessary reforms, there will be severe implications for our children, their schools, our economy and our future. If Chicago and the state of Illinois are to continue moving forward and making progress, legislative leaders must act now.”

The city’s unfunded liabilities for its four funds total $16.7 billion. They collectively were just 35.2% funded at the end of 2012, the lowest level ever, Fitch said. The city faces a $580 million increase in its contribution for its police and firefighters funds in 2015 under a previously approved state mandate to bring them to a 90% funded ratio by 2040.

The city is banking on the General Assembly to act on statewide reforms that can then be applied to local governments. Local government employee pension contributions are set by a formula in state statute, as are benefits. Emanuel earlier this year negotiated changes with the leadership of one of the city’s unions but its rank-and-file rejected the cuts.

The General Assembly ended its legislative session in May at an impasse over two rival plans. A legislative conference committee began meeting Thursday in an attempt to craft a plan that can win passage. The city is also seeking legislation to extend the deadline to increase funding for the police and firefighters funds, but its prospects are uncertain given Gov. Pat Quinn and lawmakers’ focus on state level reforms.

At the conference committee Thursday, acting state budget director Jerry Stermer reiterated Quinn’s position that the “matter of the state systems needs to be addressed before we can do something about the locals.”

While the size of the city’s unfunded obligations poses a long-term challenge, the near-term challenge is acute with the looming hike in payments that threatens to crowd out other city spending priorities. On the flipside, any deferral in improving the funds’ status adds to the long-term risks.

The city has a budget of about $6.5 billion so Emanuel has warned that the looming pension payment increase would drive a massive property-tax hike and/or deep spending and program cuts.

Chicago was among the 29 governments Moody’s Investors Service put on review for a possible downgrade in April due to its new methodology for analyzing public pension liabilities.

Emanuel earlier this year laid out a framework for city reforms in a proposed agreement with leaders of the Chicago Police Sergeants Association, but its members rejected the plan. The deal raised the retirement age, raised pension contributions, cut cost-of-living adjustments, and allowed retirees to continue to receive subsidized health care but required future retirees to contribute 2% of their annuity to defray city costs.

Moody’s rates Chicago’s GOs Aa3 and Standard & Poor’s rates the city A-plus with a stable outlook.

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