Chicago Pension Evokes Illinois Before Python Slain: Muni Credit

Squeezy the Pension Python has slithered north to Chicago.

The cartoon snake, which Illinois Governor Pat Quinn used to symbolize retiree costs that are strangling the state’s finances and undermining its credit rating, is now smothering Chicago. The third-most-populous U.S. city had its general-obligation grade cut by Moody’s Investors Service last week to three levels above junk. Excluding bankrupt Detroit and Stockton, California, that’s the lowest among the 90 biggest U.S. cities, data compiled by Bloomberg show.

The downgrade raises bond costs for Chicago, which is borrowing about $880 million this week through a sale of general obligations, said Peter Hayes at BlackRock Inc. and John Miller at Nuveen Asset Management. The city can ill afford the extra expense as it faces $590 million in additional pension payments next year, threatening a tax increase and cuts in everything from police to garbage collection.

“Chicago suffers from the delays of pension reform from the state,” said Miller, who oversees $90 billion of munis as Nuveen’s co-head of fixed income in Chicago. “They could be and should be a way better credit than this -- the problem has been clearly identified. It’s really a matter of politics.”

Springfield Hinge

Chicago’s financial fate hinges on state lawmakers in Springfield, the capital about 200 miles (322 kilometers) southwest. Illinois created the city’s pension funds, so state lawmakers must approve changes that would save Chicago money by trimming retirement benefits. State political leaders want the city and its unions to negotiate a solution.

Squeezy the serpent was featured in a November 2012 video that showed it wrapping itself around the state Capitol.

Since then, Illinois lawmakers broke through decades of gridlock, passing a pension overhaul in December. Wall Street rewarded the effort, as rating cuts subsided and buyers last month demanded a 26 percent smaller penalty to own Illinois debt. Among U.S. states, only South Dakota has seen its bonds gain more this year, Barclays Plc data show.

Chicago doesn’t have time for a long debate. Like all municipalities in the state, it must make higher pension payments next year, as required by a 2010 law.

Chicago’s Deficit

Chicago has underfunded pensions for more than a decade and faces a pension deficit of about $19 billion. The city tripled its debt load from 2002 to 2012, as it ignored retirement contributions and borrowed for operating costs, according to the Civic Federation, a nonprofit research group in Chicago.

Kelley Quinn, a spokeswoman for Mayor Rahm Emanuel, a Democrat, didn’t respond to an e-mail seeking comment on expectations for the bond sale.

Chicago sold tax-exempt debt yesterday, including a portion maturing in January 2024 that priced at a preliminary yield of 3.95 percent, according to data compiled by Bloomberg. That’s about 1.4 percentage points above benchmark debt, or almost double the yield spread from a 2012 bond issue.

Ten-year revenue bonds with a BBB rating, two steps above junk, yield 1.28 percentage points more than top-graded munis, Bloomberg data show.

Political Challenge

“Chicago has been priced more like a BBB since they were downgraded last year,” said Hayes, head of munis at New York-based BlackRock, which oversees about $108 billion of state and local debt. “Chicago has acknowledged they have a pension problem; it’s just politically difficult.”

Before this month’s cut to Baa1, Moody’s dropped Chicago’s grade in July by three levels to A3, an unprecedented move for such a large city.

North Las Vegas, Nevada, with 223,500 people, has a Ba3 rating, three steps below investment grade. That makes it the next-most-populous city to have general obligations ranked lower than Chicago’s. Chicago has a split grade because Standard & Poor’s ranks it A+, the fifth-highest grade and three steps above Moody’s.

S&P said in a Feb. 27 report that Chicago is unlikely to follow the path of Detroit. Chicago’s “sizeable tax base” and “fundamentally stronger” economy mean it will meet its obligations, the ratings company said. S&P hasn’t graded Detroit A+ or better in at least 37 years.

BMO’s Looking

BMO Asset Management Corp. is considering buying some of this deal on the view that the city’s bonds could rally on a pension fix just as the state’s securities have.

The company, which oversees about $4 billion in munis, has less Chicago debt than the benchmark it tracks, said Duane McAllister, a money manager at BMO in Milwaukee.

“2014 could be the year in which you want to begin to add to your Chicago exposure,” McAllister said. “The state legislature is going to take this up and it will be a focus.”

Before the state pension change passed in December, Illinois lawmakers had failed five times in the prior 16 months to reach a solution. The state is rated A3 by Moody’s, the lowest for a U.S. state, with a negative outlook because of five lawsuits filed against the measure.

In its March 4 report, Moody’s highlighted the importance of resolving Chicago’s unfunded pension liabilities, saying the obligations “threaten the city’s fiscal solvency.”

Crisis View

Illinois Senate President John Cullerton, a Democrat, said in a January Chicago Tribune article that it becomes “a crisis if we don’t do anything” to fix Chicago’s pension system. He and other lawmakers are “not interested in kicking the can down the road,” he said.

State lawmakers’ next chance to take up pension costs at the local level comes this month, in a term that lasts through May.

Democratic House Speaker Michael Madigan said through a spokesman that he would like to see changes in Chicago pensions negotiated between the city and the affected unions.

“That’s an excellent way to go and it would likely satisfy any constitutional test,” said Steve Brown, Madigan’s spokesman.

Public employee unions challenged the constitutionality of the pension bill Quinn signed into law. There are no signs of a bargained agreement in Chicago.

“The clock is ticking, and their backs are against the wall,” Miller at Nuveen said. “Chicago’s economic and business environment is still sound. The urgency is to fix this thing before it blows back onto the economy in a serious way.”

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