CHICAGO –  Standard & Poor’s put Chicago on notice Monday that its A-plus general obligation rating faces a downgrade due to the size of its unfunded pension obligations and the strain of a looming $600 million spike in its pension contributions.

The agency revised its outlook to negative from stable on nearly $8 billion of GO debt. “They are facing a large uptick in their contributions and are going to have to make some progress in the next 14 months” to address the burden, whether it’s through state relief, state pension reforms, or local action, analyst Helen Samuelson said.

“The city can’t afford the payment within its current revenue structure,” she said, without undertaking steep cuts that would be difficult to achieve given that much of the city’s corporate fund goes to cover personnel costs, especially for public safety.

The collective unfunded liabilities of the city’s four pension plans have risen to $19.4 billion in 2012 from$11.9 billion in 2009. Combined, they have a funded ratio of 35%. The difference between the city’s existing pension payments – set under an Illinois statutory formula – and the actuarially required contribution totaled $1 billion in 2012, or 33% of corporate fund expenses. 

The rating agency’s action Monday makes it the third to take aim at the city’s weakened credit. Moody’s Investors Service in July dropped the city’s GO rating and sales tax ratings by three notches to A3 and its water and sewer bonds by two notches. A negative outlook was assigned.

Fitch Ratings in June put the city’s AA-minus ratings on negative watch, citing concern over the near- and long-term risks of the city’s unfunded liabilities, which overshadow the city’s fiscal strides on balancing its budget.

Mayor Rahm Emanuel, who took office in 2011, has put the blame on the General Assembly for failing to enact pension reforms. State level reforms that officials envision being applied to local governments have been stalled by political differences. A legislative conference committee is expected to announce a new plan this month.

“Mayor Emanuel has said for more than a year that without comprehensive pension relief from Springfield, municipalities such as Chicago would continue to receive negative reviews from rating agencies,” city finance department spokeswoman Kelley Quinn said in a statement. “We have made significant strides over the past two years, but all of the hard work will be for nothing without pension reform.”

Interactive Data Corp. reported in mid-August that negative headlines over Chicago’s pension challenges had driven prices on the city’s GOs down in secondary trading, increasing the spread to the AAA benchmark to 191 basis points, from  previous levels of between 160 basis points and 170.

Standard & Poor’s applied its newly released local GO criteria in its review of the city’s credit, but Samuelson said given the breadth of the city’s pension struggles, an outlook revision was likely either way. The city’s credit profile was also due for a review, she added.

The A-plus rating reflects the city’s broad and diverse economy, its status as a major regional economic center, and adequate budgetary flexibility. Athough the city has home rule status allowing it flexibility to raise taxes, Emanuel has been reluctant to raise property taxes.

The rating also reflects a past reliance on one-shots to balance the budget resulting in an ongoing structural imbalance, continued budget challenges, very strong liquidity, and strong management conditions with good financial practices and policies in place. The city’s direct debt is high and it’s overall credit suffers from a “weak” institutional framework score.

Under the rating agency’s institutional framework score based on the legislative and functional environment local governments operate in, Chicago was the only municipality nationally to fall into the “weak” category based on the subcategories specific to Illinois’ municipalities, said analyst John Kenward.

Based on the application of criteria specific to Illinois, the state’s local townships, cities, villages, and counties all scored rankings of between two and three, considered strong and adequate, respectively. Only Chicago scored lower at four, which is classified as “weak.”

The two central factors that distinguished Chicago included its exemption from certain state rules on financial reporting. The other stems from the size of the city’s pension liabilities, the big difference between its actuarily required contribution and statutory payment, and mandated payment spike. The agency said it considered the looming increase a state-imposed unfunded mandate that is “both significant and potentially overhwhelming for the budget.”

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