“You need a resolution that allows a municipality to meet its obligations in a reasonable way that doesn’t destroy a government’s ability to grow and prosper,” said Chapman Strategic Advisors bankruptcy expert James Spiotto.

CHICAGO – The municipal market's buyside, as do legal experts, sees Chicago's pension reform appeal to the Illinois Supreme Court as a longshot and wants the city to come up with an alternative.

Oral arguments were held Wednesday in Chicago's appeal of a July lower court ruling that voided the city's overhaul of its laborers and municipal employees' funds. They are responsible for half of the city's $20 billion unfunded pension liabilities. Moody's Investors Service dropped the city to junk in May over its pension strains.

"Almost no one is optimistic in the market" that Chicago will prevail, said Matt Fabian, partner at Municipal Market Analytics. "It comes down to what the city does after."

Others echoed that sentiment.

"First, it's a higher burden because the lower court ruled against the city and so they would have to overturn. Second, it's an argument the court has heard before in the state case although with a different nuance," said Brian Battle, director of trading in Chicago at Performance Trust Capital Partners.

Earlier this year the state's high court overturned an overhaul of state pension plans.

Battle said the few questions posed by a couple justices suggest some "skepticism" over the city's legal arguments and only serve to fuel the market's dim view of the city's prospects.

"I think you have to assume the city's chances are very low, and the fact there is no Plan B or C is very problematic," said Michael Johnson, head of research at Gurtin Fixed Income Management LLC. "The city and state do not have a large window to find a meaningful solution."

Emanuel’s administration is holding steady in its hopes of prevailing with the court, but said an alternative would be forthcoming if not. “First, the city believes the 2014 pension reform legislation is constitutional because it does not diminish or impair benefits, but instead rescues the Municipal Employees and Laborers' pension funds from certain insolvency,” read a statement from the administration. “If SB1922 is found unconstitutional by the Illinois Supreme Court, the city would continue to work on a responsible solution that protects taxpayers, while also funding the city’s statutory obligation to the pension funds.”

Chicago asked the court's seven justices to overturn Cook County Circuit Court Judge Rita Novak's ruling voiding the city's 2014 overhaul. The city package negotiated between Mayor Rahm Emanuel's administration and unions and approved by the General Assembly violates the state constitution's pension clause that gives contractual rights to fund membership and protects benefits against diminishment and impairment, Novak concluded.

The city wants the court to look past that language and take into consideration that the overhaul calls for a massive infusion of city funding in addition to higher employee contributions and offers new funding guarantees.

Combined, they enhance the funds and rescue them from looming insolvency. The city is pressing justices to recognize that most impacted unions agreed to the changes, making them a fair, bargained-for exchange permitted under contract law.

The fund members and unions who challenged the law say the court should look no further than the language of the pension clause and find that the damage to pension annuities trumps other arguments and renders the reforms unconstitutional.

The market shouldn't read too much into oral arguments, said attorney and municipal restructuring specialist James Spiotto, a managing director at Chapman Strategic Advisors LLC.

"The presumption is with the lower court so it's always an uphill battle, but trying to read the tea leaves in oral arguments is always difficult," Spiotto said. That's because it's hard to assess motives and whether the question is indicative of a justice's position. Also, only a few justices posed questions.

"It will come down to whether the court views the pension clause as absolute or whether there is an ability on behalf of governmental bodies and workers' representatives to come up with a bargained-for resolution," he said.

That's where the city's arguments veer from the state's earlier case. Illinois argued that it could take that action under its sovereign powers to protect the public welfare in a fiscal crisis. The city says its changes stabilize the funds, which under the prior statutory funding requirements would go bankrupt.

Spiotto said the city case does pose new legal questions. It also opens the door to a larger, national question over how to balance a government's need to meet its obligations without harming its economic viability.

"You need a resolution that allows a municipality to meet its obligations in a reasonable way that doesn't destroy a government's ability to grow and prosper," Spiotto said.

The justices could affirm the lower court ruling, overturn it outright, or remand it to the lower court for further consideration.

If the court overturns the ruling, the city's credit profile gets a boost even though it might not translate into any rating action. The rating agencies have warned that the benefits of the pension overhaul take a long time to come to fruition.

If Chicago loses, it marks a setback in efforts to stabilize its finances, but the city would actually see immediate budget relief because the package called for an additional $100 million in 2016 contributions. The long strain of the growing obligation, however, poses a bigger threat to the city's balance sheet.

Battle and Fabian said the city might not see much impact on its yields if the overhaul is thrown out as the market has built their current perception into trading levels. If the city prevails, it could see yields fall.

The market will look to Emanuel to offer up a "long-term, structural solution," Battle said, that would probably involve more revenue, expense cutting, and a revised payment amortization. "The city won't lose market access but it will be more expensive" absent a fresh, structural solution, he said.

Fabian said a new solution is not urgent.

"The city's current ratings are more at risk if they revert to budget gimmicks," he said. "Because [an adverse ruling] doesn't immediately impact the budget they don't need to rush into a backup plan."

The city's general obligation spreads have narrowed to a little over 200 basis points from a high of 300 basis points largely due to market recognition of the $543 million annual property tax hike approved in October to cover rising public safety pension contributions.

The ruling will be of wide interest.

Local governments and state lawmakers are hoping for a possible roadmap on future pension reforms. If the court affirms the lower court ruling, the dual decisions of the city and state cases shut the door on any future attempts to outright cut benefits.

The high court's May ruling on the state reform legislation offered a footnote referencing consideration for a bargained-for exchange agreement on pension changes as possible roadmap and the city latched on to it as most unions signed off on the changes. Those challenging the reforms counter that individuals must agree.

The high court's May reference was just a footnote with little guidance so justices could elaborate on their thinking and whether governments can bargain with unions to change benefits or individuals must have a say.

Gov. Bruce Rauner has floated the idea of a constitutional amendment on pension benefits, although any attempt to alter accrued benefits would face a daunting legal challenge.

Rauner is also pushing for the establishment of a Chapter 9 provision in state law viewed as a means to give local government more negotiating power with unions.

The case is Jones, et al. v. Municipal Employees' Annuity and Benefit Fund of Chicago, et al.

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