Illinois payment intercept may trigger pension reckoning

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CHICAGO – Illinois’ public safety pension intercept law could force a pension funding reckoning for local governments that strains their ratings, S&P Global Ratings said Monday.

The state’s withholding this spring of a fiscally distressed Chicago suburb’s share of state-collected revenues to cover overdue pension contributions led some investors and analysts to worry that a flood of such requests could have widespread impact on local government finances. It’s also fueled broader concerns that debt service will take a backseat to pension obligations.

State Comptroller Susana Mendoza began earlier this year enforcing the law that allows police and firefighter funds outside Chicago to seek the diversion of revenues if they go through a certification process with the office. The provision was included in a 2011 public safety pension funding law that required actuarial contributions sufficient to reach a 90% funded ratio by 2040.

While it’s too soon to tell the extent of the law’s use, “we believe other pension boards may use the intercept mechanism, given chronic underfunding among many of the approximately 656 suburban and downstate public safety pension plans," wrote S&P analyst Eric Harper.

The statute's use could hasten a fiscal reckoning that would otherwise likely be spread out over many years, S&P said in the report.

“Should the intercept law's use become commonplace, significant credit strain could result across a sector that has already struggled to effectively deal with rising pension costs," Harper said.

The new enforcement drew attention after the fiscally troubled city of Harvey located south of Chicago announced deep cuts to its public safety staff due to the state’s withholding of about $1.4 million to meet a certified request by its police fund to cover a $7 million court judgment.

The withholding has since risen to about $2.1 million, according to comptroller spokesman Abdon Pallasch. The comptroller also has a request from Harvey’s firefighters’ fund to cover an $11 million judgment. The state also received a claim from North Chicago’s firefighters fund to meet an $850,000 shortfall. The funds to fully meet the claim have been withheld and the town has not filed a protest.

Harvey challenged the withholding and the comptroller is conducting a certification review that could result in the release of withheld funds to the Harvey police fund by next week. Harvey is pursuing legal action to block the diversion with its request for a preliminary injunction pending before a Cook County Circuit Court judge. A hearing is set for Thursday. The comptroller’s office has said it hopes the city can strike an agreement with both its funds.

The law stands to have a sweeping short- and long-term impact statewide including the potential to instill more funding discipline, S&P said.

“While state intercept would weaken any municipality's financial position (to varying degrees), in our view, those with a greater share of total revenues coming from state sources would be most affected,” S&P said.

S&P does not rate Harvey. It rates North Chicago A with a stable outlook.

Some local governments may take preemptive action. “While this would likely result in budgetary strain--and in some cases, near-term credit stress--it could also result in healthier pension funding levels, lessening pension payment acceleration…ultimately, the direct effects of the state intercept law rest with municipalities' pension funding discipline and the individual decisions of pension boards,” S&P said.

S&P echoed warnings from others based on state fiscal 2016 data that many local government contributions have fallen short of required levels. Some have warned hundreds of pension funds could seek use of the intercept. Local government public safety pensions outside Chicago are carrying about $9.9 billion of unfunded liabilities with a collective funded ratio of 57.58%.

Moody’s Investors Service in previous reports has raised concerns that holders of local debt in Illinois could take a backseat to public safety pension obligations.

“The court’s decision is credit negative for Harvey, whose financial distress thus far demonstrates that municipal pensions are ‘must-pay’ obligations under Illinois law and have greater protection against default than a city’s general obligation bonds,” Moody’s wrote recently after the Illinois Supreme Court sent Harvey’s request for a preliminary injunction back to the lower courts for further review.

Harvey is not rated by any rating agency and it has previously defaulted on some debt service payments.

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