Jan 24 - Fitch Ratings assigns an 'A' rating to the following general
obligation (GO) bonds of the State of Illinois:
--$500 million General Obligation Bonds, Series of February 2013
The bonds are expected to sell via competitive bid January 30, 2013.
Fitch maintains the Negative Watch on the 'A' rating of approximately $26.6
billion outstanding GO bonds of the State of Illinois.
Direct general obligation, full faith and credit of the state of Illinois
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'
legislative session that ended on Jan. 8.
BUDGET HAS STABILIZED WITH TAX INCREASE: Following several years during which
the state was unwilling to take action to restructure its budget to achieve
balance and increasing reliance on borrowing to close budget gaps, temporary
increases in the personal and corporate income tax rates and spending limits
enacted in early 2011 closed a significant portion of the structural gap in the
state's budget through fiscal 2014. The enacted fiscal 2013 budget is balanced,
in part through passage of Medicaid reform.
NEED FOR LONG-TERM SOLUTION: Due to the temporary nature of the enacted tax
increases, the state will need to find a more permanent solution to the mismatch
between spending and revenues particularly as it faces steep increases in annual
ACCOUNTS PAYABLE BACKLOG REMAINS: The state relied on payment deferrals to
manage its operating deficit through the downturn and the resulting accounts
payable backlog totaled $5 billion at the end of fiscal year 2012. Although the
balance is budgeted to be reduced during the current fiscal year, the state is
unlikely to bring its payment obligations current in a timely manner in the
absence of borrowing for this purpose.
LONG-TERM LIABILITIES HIGH: The state's debt burden is above average and has
risen over the past few years with issuance for operational purposes. Further,
there is a large unfunded pension liability, despite the issuance of pension
obligation bonds and passage of pension reform in March 2010. Pension funding
places a large and growing demand on the state's budget.
ECONOMY A CREDIT STRENGTH: The state benefits from a large, diverse economy
centered on the Chicago metropolitan area, which is the nation's third largest
and is a nationally important business and transportation center.
GO PLEDGE STRONG: There is 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 twelve months.
WHAT COULD TRIGGER A RATING ACTION
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.
In addition, deterioration in the state's financial position, as evidenced by
excessive use of non-recurring revenues or additional payment deferrals, could
lead to negative rating action. Pushing up against the expiration of temporary
tax increases in fiscal 2015 without a solution in place would also put extreme
pressure on the budget and likely lead to a rating action.
The 'A' rating reflects the challenges faced by the state of Illinois in
achieving budget balance despite the significant revenue raising action taken in
fiscal 2011 to realign its financial operations as well as sizeable unfunded
pension liabilities that are placing increasing pressure on the state's
operations. The increase in tax revenue, in conjunction with enacted hard
spending limits moved the state closer to budgetary balance for three fiscal
years, beginning in fiscal 2012.
Medicaid reforms implemented in the fiscal 2013 budget make significant progress
toward alleviating some pressure on the general fund. However, large challenges
remain, including rising pension costs, a significant accounts payable balance,
and maintaining budgetary balance in light of the temporary nature of the tax
increases. The tax increases will begin to phase out in 2015; thus, even if the
state maintains budget balance to that point, it will once again be faced with a
significant budget balancing decision to make permanent the tax increases, make
severe expense reductions, or identify new revenues.
The tax increase followed several years during which the state had been
unwilling to take action to restructure its budget either through revenue
raising or spending reductions. Illinois entered the recession with little
financial flexibility having not taken actions to build its reserves or
restructure its finances as the economy grew over the five years leading into
the downturn. During the recession, the state instead relied on borrowing to
close budget gaps and increasingly delayed payments to service providers,
vendors, and local governments, resulting in an accumulation of accounts
payable. As of June 30, 2012 the accounts payable balance was $5 billion, or 17%
of state based general fund revenues. Although the accounts payable balance is
budgeted to decrease to $4 billion in fiscal 2013, there is currently no
expectation that this balance will be more meaningfully reduced in the
foreseeable future, barring a decision to issue bonds to fund the backlog. The
accounts payable figure does not include incurred liabilities, primarily related
to Medicaid and group health insurance, for which budgeted appropriations were
insufficient; these liabilities totaled an additional $3.8 billion at the end of
The fiscal 2012 budget appropriated at a level below hard dollar caps on
spending for operations; however, the budget was not balanced, and despite
deferring $1 billion of Medicaid spending into the current fiscal year, the
state ran a $121 million operating deficit. General fund revenues met
expectations, with personal income taxes growing 38.2% year-over-year and
corporate income tax revenues growing 33% year-over year, both led by the tax
increase but with some reported growth in the base as well. Sales tax revenues
grew 5.8% in fiscal 2012.
The enacted fiscal 2013 budget assumes modest revenue growth and required
spending controls to achieve balance. Through the first half of the fiscal year,
state revenues have increased 5.1% year-over-year led by 7.9% growth in income
tax revenues and are higher than forecast. The enacted budget forecasts a $1.5
billion operating surplus, although that is somewhat overstated as employee
health benefits (totaling approximately $550 million) were not fully funded in
the budget prior to the conclusion of the collective bargaining process. The
budget included significant Medicaid reforms that closed a $2.7 billion
projected program gap with $1.6 billion in spending reductions, $700 million in
increased revenue generated from a $1 per pack increase in the cigarette tax
(including federal matching funds), $100 million in hospital assessments, and
increased funding from the general fund. Expense controls include changes in
eligibility, elimination of some optional services, and reimbursement rate
reductions. The budget did not directly address the accumulated accounts payable
backlog although any operating surplus will flow to reducing the backlog.
The state's net tax-supported debt, at 6.2% of 2011 personal income, is at the
high end of the moderate range and debt levels have increased with the state's
issuance of GO bonds for operational purposes in fiscal years 2010 and 2011.
Debt amortization is average at 52% in ten years; the heavily back-loaded
structure of the pension obligation bonds issued in 2003 is offset by the rapid
amortization of the recent bonds issued for pension payments. Illinois provides
a strong GO bond pledge, including 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 one year ahead on
a rolling 12-month basis.
Other long-term liabilities, particularly pension liabilities, are very high for
a U.S. state and Illinois faces continued significant growth in funding
requirements to address the pension systems' large unfunded liabilities. As of
June 30, 2012, the unfunded actuarial accrued liability was reported at $94.6
billion, resulting in a 40.4% reported funded ratio, a level which reflects the
use of five-year smoothing. The passage of a first round of pension reform, in
March 2010, which established a two-tier pension system for public employees,
raised the retirement age, and scaled back growth in benefits, will reduce the
state's future liabilities. However, in the near term, pension funding
requirements will increase significantly. Growing pension payments are crowding
out other expenditure growth as well as any revenue growth. Pension payments
from the general fund represent 15.5% of fiscal 2013 operations and increased by
23% to $5.1 billion for the year, in part due to the use of more conservative
investment return assumptions included in the most recent pension valuation.
Fitch believes that the burden of large unfunded pension liabilities and growing
annual pension payments is unsustainable.
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 local government employers and
establishing a 30-year funding schedule based on the actuarially required
contribution (ARC) that aims to reach 100% funding by 2043. 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 Illinois economy is centered on the Chicago metropolitan area, which is the
nation's third largest and a nationally important business and transportation
center. Illinois' economy has gradually shifted, similarly to the U.S. in
general, away from manufacturing to professional and business services. The
remaining manufacturing sector includes more resilient non-durables, and is less
concentrated in the auto sector than are surrounding states (Indiana, Michigan,
and Ohio). While the state economy was not as negatively affected by the
recession as some of these neighboring Midwestern states, it did contract faster
than the national economy. Total non-farm employment declined 4.9% in 2009,
versus the national rate of 4.4% and essentially matched the U.S. rate of
decline at 0.8% in 2010. Modest growth resumed in 2011 with year-over-year job
gains of 0.9%, below the national rate of 1.1%. Illinois's job recovery
continues to be weaker than the national recovery with 0.7% year-over-year
growth in non-farm employment as of December 2012 versus the U.S. growth rate of
1.4%. The state's unemployment rate has typically exceeded that of the U.S. over
the past decade and was 112% of the U.S. at 8.7% as of December. Wealth levels
remain above average. Per capita income is 106% of the national average,
fourteenth among the states.
Additional information is available at 'www.fitchratings.com'. The ratings above
were solicited by, or on behalf of, the issuer, and therefore, Fitch has been
compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria' (Aug. 14, 2012);
--'U.S. State Government Tax-Supported Rating Criteria' (Aug. 14, 2012);
--'Fitch Places Illinois GO Bonds on Rating Watch Negative' (Jan. 11, 2013).
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
U.S. State Government Tax-Supported Rating Criteria