OREANDA-NEWS. Fitch Ratings has assigned a 'BBB+' rating to the following Chicago, Illinois obligations:

--$498.14 million general obligation (GO) refunding bonds series 2015C;
--$1.86 million GO refunding bonds taxable series 2015D.

Fitch also affirms the following ratings:

--$9.5 billion unlimited tax GO bonds at 'BBB+'.

The Rating Outlook remains Negative.

SECURITY

The ULTGO bonds are payable from the city's full faith and credit and its ad valorem tax, without limitation as to rate or amount.

KEY RATING DRIVERS

PENSION FUNDING RISKS PARAMOUNT: The Negative Outlook reflects the uncertainty regarding the prospects for sustainable and affordable funding of pensions. The outcome of the legal challenge to the city's pension reform legislation is still unknown and an adverse decision could cause a further downgrade.

UNDERLYING FUNDAMENTALS REMAIN SOUND: The 'BBB+' rating recognizes the city's role as an economic hub for the Midwestern region of the United States with a highly educated workforce and improving employment trends. Aside from its pension funding issues, Chicago's financial profile has markedly improved in recent years, although full structural balance remains a challenge. The city's independent legal authority to raise revenues remains a key credit strength.

RATING SENSITIVITIES

PENSION FUNDING RISKS: Implementation of pension solutions that move all of the city's pension plans on a clear path towards adequate, actuarially-based funding while preserving sustainable budgetary balance is necessary to stabilize the credit. Absent that, the rating is likely to be downgraded.

ADEQUATE RESERVE MAINTENANCE: The city's reserves, including those in the general fund as well as the long-term reserve funds, are an important aspect of the city's overall credit quality. Drawing upon those reserves could trigger a downgrade.

CREDIT PROFILE

LONGER-TERM LIABILITIES A CHIEF CONCERN

The city continues to face credit challenges related to critically-underfunded pension obligations and rising associated costs. The Outlook for the city's credit quality cannot be considered stable until such challenges are met in a sustainable fashion.

The weight of the city's extremely large unfunded pension liability is compounded by the high (8.7% of market value) debt burden, which is the product of substantial borrowing by the city as well as overlapping jurisdictions. Many of these overlapping governments also maintain underfunded pensions, and Fitch remains concerned that the funding requirements for all of these long-term liabilities will pressure the resource base in the coming years.

The city maintains four single-employer defined benefit pension plans, all of which are poorly funded due to a statutory funding formula which has fallen far short of actuarial requirements. In fiscal 2014, the combined actual pension contribution amounted to just a quarter of the actuarially determined requirement. The combined unfunded liability for all four plans is reported at approximately $20 billion, yielding a very low funded ratio of 34% or an even lower estimated 32% when adjusted by Fitch to reflect a 7% rate of return assumption.

PENSION REFORM CHALLENGE DECISION IMMINENT FOR TWO PLANS
Last year, the state legislature passed pension reform legislation (SB 1922), covering two of the city's four pension plans (Municipal and Laborers), which was subsequently challenged in court. The legislation includes some changes to the benefit structure that reduce the liability, as well as a multi-year ramp up in contributions.

The city contends its reform should pass constitutional muster because the reform preserves and protects benefits, rather than diminishing or impairing them. The basis for this contention is that prior to the pension reform legislation, under Illinois statute the city was not legally responsible for the unfunded liability of the Municipal and Laborers' pension funds. Without reform, those two funds faced depletion in 10 - 13 years.

Under SB 1922, the city assumed that legal burden only as part of the overall pension reform package legislation, and, it contends, thereby is preserving the benefits rather than impairing them.

The circuit court struck down the reform legislation and the city appealed directly to the Illinois Supreme Court. Oral arguments were heard in November and a decision is expected at any time. If the pension reform changes to the COLAs and employee contributions are struck down by the Supreme Court, the city would likely revert to the lower, statutorily based payments. Under this scenario, the related liability could be expected to continue to rise and the rating would likely be downgraded.

POLICE AND FIRE PLANS REQUIRE INCREASED PAYMENTS

The city is no longer pursuing benefit changes related to the Police and Fire pension plans, Rather, the city's focus is now on easing the transition to the statutorily-imposed, much higher actuarially based payments.

The existing formula requires a contribution that would be sufficient to bring both systems to a 90% funding level by 2040 - a 25-year amortization schedule that is more aggressive than the city's other plans. The state legislature passed a bill that would change the amortization period to 40 years and allow for a ramp up period to the 90% actuarially based funding level in 2020. Those two changes are estimated to lessen the increase in the first year's payment from $530 million to $330 million. The legislature has not sent the bill to the governor for his signature. If not signed, it would become law 60 days after receipt by the governor. The fiscal 2016 budget includes funding for the lower payment on the assumption that the bill will ultimately be signed before the payment is due. The payment is due by the end of the year. If the bill is not signed, city officials have said they would make the required higher payment, with the difference likely coming from short-term borrowing proceeds.

PENSION CHALLENGES OVERSHADOW IMPROVED FINANCIAL PERFORMANCE

Management has made significant progress toward matching ongoing revenues with non-pension annual expenditures. Fitch will not consider the city's financial operations to be structurally balanced in the absence of a sustainable, actuarially-based pension funding structure. Successful execution of the city's plan toward financially sustainable practices would be considered a positive rating factor. Remaining plan elements include the elimination of scoop-and-toss refundings by 2019, the use of current funds to pay legal settlements or judgments, and growth of the 'rainy day fund.'

Audited fiscal 2014 results show the general fund recorded a $25 million net operating deficit after transfers, equivalent to -0.8% of spending in fiscal 2014. This compares favorably to the budgeted appropriation of $53.4 million of general fund balance.

The city ended the practice of appropriating reserves beginning with fiscal 2015. The $3.5 billion fiscal 2015 general fund budget was balanced with a reduced but still significant amount of one-time measures, including scoop-and-toss refunding. The city expects to end fiscal 2015 on budget, with no use of fund balance anticipated.

The $3.6 billion fiscal 2016 general fund budget closed the previously identified budget gap of $232.6 million through a variety of recurring and one-time measures and no appropriation of general fund balance. Fitch believes the budget target is achievable given the city's recent history of budgetary adherence. Despite the progress made, the city's budget still requires some non-recurring measures for balance, which is concerning several years into an economic recovery.

REVENUE CONTROL AND RESERVES KEY

Fitch views the city's home rule status as a credit strength, fostering revenue independence and flexibility. The general fund derives support from utility taxes, state sales taxes, transaction taxes, and recreation taxes among others. The general fund does not rely upon property taxes for operations, as they are earmarked for pensions, library expenses and debt service.

The audited fiscal 2014 unrestricted general fund balance dropped to 3.6% from 4.6% of spending a year prior. Fitch views the approximately $626 million, equivalent to 19.4% of fiscal 2014 general fund spending, in the service concession and reserve fund as an important element of financial flexibility. A draw on reserves would signal an increasing reliance on non-recurring measures and could trigger a rating downgrade.