CHICAGO – A court ruling ordering a fiscally distressed Chicago suburb to raise its firefighter pension contributions could pit pensioners against general obligation bondholders, Moody’s Investors Service warns.

An Illinois appellate court last year upheld a trial court decision from 2015 ordering Harvey to levy a property tax to meet its firefighter pension fund obligations. The appeals court went a step further and concluded – in a first of its kind ruling in Illinois – that the fund was on the “verge of default.”

The city south of Chicago was already tarnished by bond defaults and federal sanctions for misleading bondholders. It began defaulting on a 2007 issue in 2015 and has made good on some payments but the defaults are ongoing.

If the ruling holds, the city must make good on $11 million owed to the pension fund. The city’s petition for a rehearing was denied last month. The city could appeal to the state Supreme Court. The city did not return a request for comment on the case or status of its bond payments.

“With the court ruling, Harvey must increase pension contributions even while GO debt goes unpaid,” Moody’s wrote in a sector report, “Harvey court ruling highlights Illinois' pension protections,” published this week.

Moody’s does not rate Harvey and while the report looks more broadly at the potential impact of the ruling statewide, it delves deeply into the suburb’s strained finances.

“Future revenue increases needed to provide services and pay bondholders could be difficult for the city to enact. Under state law, the city cannot file for bankruptcy, so a state court, not a bankruptcy judge, may hear the arguments of pensioners and bondholders,” Moody’s continued. No bondholder action has been reported.

Moody’s described the city’s fiscal position as “extraordinarily distressed” with an available operating fund balance that was a negative $51.6 million at the end of fiscal 2016. The city has $43 million of debt outstanding and an adjusted net pension liability based on Moody’s calculations of $87.3 million which equates to 3.6 times operating revenue and exceeds the median of 3% for all Illinois cities.

The city’s burdens are supported by a modest $574.2 million tax base that is depreciating at an average annual rate of 7.5%. Harvey has a poverty rate of 36.4% compared to the national rate of 15.5%.

“Harvey's apparent inability to pay the court-ordered $11 million-plus in pension funding and/or make bondholders whole is underscored by its weak financial position, small tax base and heavy debt burden,” Moody’s said.

Moody’s said the ruling underscores the stringent protections afforded pension benefits by the state constitution; under 2016 legislation municipalities must comply with minimum pension funding requirements.

Under the new rules, police and firefighter pension boards are empowered to petition the state comptroller if their local city fails to meet the minimum requirement payment and the comptroller can withhold a portion of the local government's state funding and send it to the fund. The mechanism, however, has not yet been put in place to take the action.

The state requires single-employer local government public safety pension funds to reach a 90% funding fund ratio on a reported basis by 2040.

The majority of cities rated by Moody’s are making pension contributions at, near, or above the state minimum but the targets are failing to keep the net liabilities from growing, Moody’s said.

In the Harvey case, the appellate court found 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." The fund was at about a 25% funded ratio based on 2016 reporting.

Moody’s said the funded ratio of Harvey's firefighters' fund is similar to a small percentage of other public safety pension plans in Illinois which signals that some are struggling. Of the 649 public safety plans in the state, about 27 had funded ratios below 25%.

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 2014 settlement with the Securities and Exchange Commission for misleading bondholders on the use of bond proceeds.

The city’s tax-exempt piece of the 2007 deal has recently traded at 64 to 66 cents on the dollar, according to the Municipal Securities Rulemaking Board's EMMA site.

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.”

Harvey paid principal on its taxable GOs eight months late. Some tax-exempt GO coupon payments have been late and remain in arrears, according to one Harvey GO bondholder, who added, the city does not respond to calls to discuss the defaults.

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