CHICAGO – The messy funding battle in Harvey, Illinois, is credit negative for municipal governments across the state, Moody's Investors Service said Tuesday, as it further reinforces the idea that holders of Illinois local government bonds fall behind pension funds.

In Harvey, the Illinois comptroller concluded the distressed city’s police retirement fund is entitled to the city’s share of state-collected revenue to make up for delinquent contributions.

State Comptroller Susana Mendoza issued her finding May 21 in the first enforcement case involving the intercept provision in a 2011 public safety pension funding statute. The police fund made the diversion request to settle a $7 million judgment for past contribution shortages.

Tom Aaron
The Illinois comptroller "clearly prioritizes underfunded pensions over municipal services," wrote Moody's analyst Tom Aaron.


“The decision is the latest in a series of events involving Harvey that reinforce strong protections for pensions to the detriment of bondholders, and is thus credit negative for Illinois’ local governments,” wrote analyst Tom Aaron in Moody’s weekly outlook publication.

“The comptroller’s response has important implications for other Illinois municipalities that are struggling to provide services and pay pensions because it clearly prioritizes underfunded pensions over municipal services,” Aaron added.

Of the 649 public safety plans in the state, approximately 27, or 4%, had funded ratios below 25%, an indication that other plans may face similar challenges to Harvey, Moody’s has warned. Other reports have warned that hundreds of local governments' public safety pension funds have received contributions short of an actuarially determined level.

The comptroller’s office has so far withheld $2.3 million from Harvey, but Cook County Circuit Court Judge Raymond Mitchell blocked the scheduled distribution of funds last week, primarily based on a competing claim from the firefighters' pension fund, which is owed even more, that it would be harmed if it can’t share in the distribution.

The Harvey crisis became public in April after Mayor Eric Kellogg announced deep cuts to firefighter and police ranks due to the withholding.

Harvey, which is unrated, has already defaulted on a handful of general obligation debt service payments over the last few years. The impoverished Chicago suburb suffers from poor property tax collections and is “structurally insolvent” with a negative fund balance of $56 million which equals 199% of revenue, Moody’s said.

“Although Harvey cannot currently file for bankruptcy under Illinois law, revenue withholding for pensions only heightens the likelihood of more bond defaults and a restructuring,” Moody’s said.

Harvey’s lawsuit challenging the withholding is pending before Mitchell. The city argues the pension funds are not entitled the revenue for judgments on contributions owed in past years and that bondholders have a first claim on the revenues.

The city is still trying to reach a settlement with both funds but it’s been stymied by arguments between the police and firefighters' funds over how much each should receive. The firefighters' fund wants the court to include its $12 million judgment in any distribution while the police fund argues it was first to submit a claim and should be paid first. The comptroller would also like the court to weigh in on the priority of competing claims because the state law does not address that subject.

A court hearing is slated for Thursday during which the judge could leave the temporary restraining order in place or lift it.

The court did free up the city’s share of locally imposed home rule sales tax which the comptroller concluded don’t meet the “state fund” designation under the law. Those funds so far totaling $278,000 were sent to holders of $6 million of city hotel-motel sales tax revenue bonds whose indenture carries a direct intercept.

Moody’s said it believes at least 25%, or roughly $5.4 million, of the city’s $21.9 million of budgeted general fund revenue in fiscal 2017 was eligible for withholding under the comptroller’s announced framework.

“Since the city’s two pension judgments amount to nearly $20 million, it will likely take several years of revenue withholding to retire the obligations unless a court intervenes, a settlement is reached or state law is changed,” Moody’s said.

The comptroller has said the city’s revenues from the state in fiscal 2017 totaled $7.16 million.

The diverted funds come from Harvey's share of local income taxes, its share of the state use tax, and other state funds including a video gambling tax, motor fuel tax allotment, and the municipal 1% share of sales tax, according to comptroller's spokesman Abdon Pallasch.

The city’s more recent payments to the pension funds subsequent to the judgment still fall short of an actuarial level so future diversion requests could be made on them too. Moody’s reviewed firefighter contributions and found the fiscal 2016 payment of just under $500,000 fell short of the nearly $2 million actuarial level while a 2017 contribution of just under $2 million fell short of the more than $2.5 million actuarial level.

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