Fitch Places Illinois GO Bonds on Rating Watch Negative
11 Jan 2013 11:42 AM (EST)
Fitch Ratings-New York-11 January 2013: Fitch Ratings has placed the 'A' rating on the general obligation (GO) bonds of the State of Illinois on Rating Watch Negative. The rating action affects approximately $26.2 billion in outstanding GO bonds of the state. Ratings linked to the state GO rating, listed at the end of this release, have also been placed on Rating Watch Negative.
The Rating Watch Negative reflects the ongoing inability of the state to address its large and growing unfunded pension liability, most recently through the failure to pass pension reform in the 'lame duck' portion of the 97th general assembly legislature that ended on Jan. 8. Fitch believes that the burden of large unfunded pension liabilities and growing annual pension expenses is unsustainable. The Rating Watch Negative will be resolved after an assessment of the extent to which the state takes action within the next six months that limits the impact of pension payments on the budget while bolstering pension funded levels. Failure to achieve meaningful results would lead to a downgrade of the rating.
Illinois's long-term liabilities, particularly pension liabilities, are very high for a U.S. state. As of June 30, 2012, the unfunded actuarial accrued liability was reported at $94.6 billion, resulting in a 40.4% reported funded ratio. This large unfunded pension liability is despite the issuance of pension obligation bonds and passage of bipartisan comprehensive pension reform affecting new employees in March 2010.
Annual pension funding requirements have been increasing significantly and growing pension payments are crowding out other expenditure growth and absorbing revenue growth. Pension payments from the general fund increased $965 million to $5.1 billion in 2013, an increase of 23%, reflecting in part the use of more conservative investment return assumptions. Fitch notes that even these large payments, which consume a well-above-average percentage of the state's general fund budget, are based on statutory formula and are below the actuarially required contribution (ARC).
Several reform proposals have been presented by the governor and various legislators that would adjust benefits for existing employees, increase employee contributions, limit cost of living increases, and increase the retirement age. Other proposed structural changes to the pension program include shifting some responsibility for employer contributions to school districts and state universities and establishing a 30-year funding schedule based on the ARC that aims to reach 100% funding by 2042. Under current statute, annual contributions are designed to reach 90% funding by 2045. Fitch believes that enactment of reform is critical to the long-term stability of the state's fiscal position, although legal protection of pension benefits is particularly strong in Illinois and Fitch expects any changes to be litigated.
The 'A' rating on Illinois's GO bonds reflects the state's broad based and diverse economy offset by the challenges presented by a budget that is balanced through significant temporary tax increases, high long-term liabilities including pensions, and a large accounts payable backlog that reflects the payment deferrals the state used to manage its operating deficit through the downturn.
The state's GO bonds benefit from an irrevocable and continuing appropriation for all GO debt service, and continuing authority and direction to the state treasurer and comptroller to make all necessary transfers from any and all revenues and funds of the state. The state funds debt service in advance by setting aside 1/12 of principal and 1/6 of 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 rating action, please see the Fitch release titled 'Fitch Affirms 'A' Rating on Illinois 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 has placed on Rating Watch Negative the 'A-' rating of the following credits, which rely on state appropriation and are rated one notch below the state GO rating:
--$438 million Illinois Sports Facilities Authority, sports facilities bonds (state tax supported) series 2001.
Illinois is #7 on CMA's top ten list of sovereigns most likely to default based on their credit default swaps. Illinois is above Portugal and below Ukraine. Here's a snapshot from CMA's website.