Fitch Ratings has placed the ‘A’ rating on the general obligation (GO)bonds of the State of Illinois on Rating Watch Negative. The ratingaction affects approximately $26.2 billion in outstanding GO bonds ofthe state. Ratings linked to the state GO rating, listed at the end ofthis release, have also been placed on Rating Watch Negative.
The Rating Watch Negative reflects the ongoing inability of the state toaddress its large and growing unfunded pension liability, most recentlythrough the failure to pass pension reform in the ‘lame duck’ portion ofthe 97th general assembly legislature that ended on Jan. 8. Fitchbelieves that the burden of large unfunded pension liabilities andgrowing annual pension expenses is unsustainable. The Rating WatchNegative will be resolved after an assessment of the extent to which thestate takes action within the next six months that limits the impact ofpension payments on the budget while bolstering pension funded levels.Failure to achieve meaningful results would lead to a downgrade of therating.
Illinois’s long-term liabilities, particularly pension liabilities, arevery high for a U.S. state. As of June 30, 2012, the unfunded actuarialaccrued liability was reported at $94.6 billion, resulting in a 40.4%reported funded ratio. This large unfunded pension liability is despitethe issuance of pension obligation bonds and passage of bipartisancomprehensive pension reform affecting new employees in March 2010.
Annual pension funding requirements have been increasing significantlyand growing pension payments are crowding out other expenditure growthand absorbing revenue growth. Pension payments from the general fundincreased $965 million to $5.1 billion in 2013, an increase of 23%,reflecting in part the use of more conservative investment returnassumptions. Fitch notes that even these large payments, which consume awell-above-average percentage of the state’s general fund budget, arebased on statutory formula and are below the actuarially requiredcontribution (ARC).
Several reform proposals have been presented by the governor and variouslegislators that would adjust benefits for existing employees, increaseemployee contributions, limit cost of living increases, and increase theretirement age. Other proposed structural changes to the pension programinclude shifting some responsibility for employer contributions toschool districts and state universities and establishing a 30-yearfunding schedule based on the ARC that aims to reach 100% funding by2042. Under current statute, annual contributions are designed to reach90% funding by 2045. Fitch believes that enactment of reform is criticalto the long-term stability of the state’s fiscal position, althoughlegal protection of pension benefits is particularly strong in Illinoisand Fitch expects any changes to be litigated.
The ‘A’ rating on Illinois’s GO bonds reflects the state’s broad basedand diverse economy offset by the challenges presented by a budget thatis balanced through significant temporary tax increases, high long-termliabilities including pensions, and a large accounts payable backlogthat reflects the payment deferrals the state used to manage itsoperating deficit through the downturn.
The state’s GO bonds benefit from an irrevocable and continuingappropriation for all GO debt service, and continuing authority anddirection to the state treasurer and comptroller to make all necessarytransfers from any and all revenues and funds of the state. The statefunds debt service in advance by setting aside 1/12 of principal and 1/6of interest every month for payments due in the ensuing 12 months.
For more information on Fitch’s ‘A’ GO rating on the State of Illinois,including other key rating drivers and possible triggers for ratingaction, please see the Fitch release titled ‘Fitch Affirms ‘A’ Rating onIllinois GO Bonds; Outlook Stable’ dated Sept. 7, 2012 and available at ‘www.fitchratings.com‘.
In conjunction with the action on the state’s GO rating, Fitch hasplaced on Rating Watch Negative the ‘A-‘ rating of the followingcredits, which rely on state appropriation and are rated one notch belowthe state GO rating:
–$438 million Illinois Sports Facilities Authority, sports facilitiesbonds (state tax supported) series 2001.
Additional information is available at ‘www.fitchratings.com‘.
The ratings above were solicited by, or on behalf of, the issuer, andtherefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
–‘Tax-Supported Rating Criteria’, dated Aug. 14, 2012.
–‘U.S. State Government Tax-Supported Rating Criteria’, dated Aug. 14,
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
U.S. State Government Tax-Supported Rating Criteria