Fitch Ratings has assigned an 'A' rating and placed on Rating Watch Negative $3.466 billion of State of Illinois general obligation bonds (GOs) taxable series of January 2010. The bonds are expected to sell via negotiation on Jan. 8, 2010. In addition, the 'A' rating on $19.4 billion of outstanding Illinois long-term GOs is also placed on Rating Watch Negative, as are ratings related to the state based on its appropriation, as noted at the end of this commentary.
RATING RATIONALE:
--The Rating Watch Negative placement reflects the magnitude and persistent nature of the state's fiscal problems and will be resolved after an assessment of the extent to which the state addresses its funding imbalances in the context of the legislative session that begins in February and the development of a budget for fiscal year 2011.
--A key factor underlying the state's rating is its poor financial performance. The enacted fiscal 2010 budget did not address the sizeable accumulated deficit and relied on non-recurring measures, including the current borrowing, to close the current fiscal year budgetary gap.
--Deteriorating revenues and an inability to achieve the budgetary measures enacted have opened up a $2 billion gap in the FY 2010 budget, equal to 7% of general fund resources.
--Despite issuing a total of $2.25 billion in short-term notes (in June and August), the state's cash position is weak. Repayment of the notes will contribute to an increase in the accounts payable backlog by $2 billion to $5.9 billion by the end of this fiscal year, equal to 21% of general fund resources. The state continues to manage its budgetary deficit by deferring payments to vendors and others.
--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. Illinois entered the current recession later than the national average and is likely to emerge later as well.
--The state's debt burden is moderate and mostly general obligation. However, additional borrowing is expected under the $31 billion capital plan. Further, there is a large unfunded pension liability, despite the issuance of pension obligation bonds. The funded ratio fell to 54.4% as of June 30, 2008, after peaking at only 62.6% funded in 2007.
WHAT COULD TRIGGER A DOWNGRADE:
--Failure to enact budgetary measures that significantly reduce the deficit on an ongoing basis;
--Failure to address the cumulative budget deficit and significantly reduce the accounts payable balance.
SECURITY:
--Direct general obligation, full faith and credit of the state of Illinois.
CREDIT SUMMARY:
The state's rating was downgraded to 'A' from 'AA-' in July 2009, at which time Fitch noted the significant scope of the state's budgetary problem and its failure to enact a budget that fully addressed current spending needs and a large structural budget deficit. Now halfway through the fiscal year, the fiscal situation has deteriorated, both due to a decline in economically sensitive revenues as well as the inability of the state to implement important elements of its budget. The state is facing a growing budget deficit, soaring accounts payables, and a significant structural gap for which solutions have been difficult to identify and implement.
Illinois entered this economic cycle with little financial flexibility to handle a downturn. It came out of the last recession relatively late and did not take actions to build its reserves or restructure its finances as its economy and the national economy grew over the five years leading into this recession. While the extent of the current fiscal problem was clear midway through fiscal year 2009 as revenue estimates were downsized, comprehensive solutions have been repeatedly delayed. Faced with reduced revenues and an aversion to broad based tax increases, the fiscal year 2010 enacted budget relies heavily on non-recurring revenues, particularly the use of debt to finance current operations, including the current offering which is sized to cover the annual pension payment. The budget included an equivalent amount appropriated as a lump sum to be allocated by the Governor, freeing up general fund resources. Other measures taken to balance the fiscal 2010 budget include $1 billion in budget cuts that were to be determined by the governor, $580 million in funds sweeps and transfers, and $561 million in savings from debt restructuring.
It is becoming evident that the assumptions underlying the budget were not sufficiently conservative and the measures implemented to close the budget gap have not succeeded. With unemployment higher than anticipated, personal income tax revenues designated for the general fund are now projected to be $767 million lower than budgeted, a 5.5% decline from the budget. The proposed debt restructuring is delayed or cancelled and more than half of the expected savings to be derived from staff reductions and facilities closures, etc., are not materializing. As a result, a $2 billion gap (7% of general fund resources) has opened in the fiscal 2010 budget, for which there are no solutions currently proposed other than to delay payments to vendors and schools districts and other entities that rely on state payments.
Taking into account the pension payment that is effectively covered by the current offering rather than general fund resources, the budgetary deficit has grown to almost $5.5 billion, 20% of general fund resources. The cumulative deficit, which includes the carry over of $3.95 billion in prior year deficits, is now projected to be $9.1 billion, or 32% of general fund resources. Further consideration of an income tax increase or other balancing measures has been postponed until later in the fiscal year. The income tax increase as it was proposed last year, which had been expected to generate approximately $3 billion, would not be sufficient to balance the budget.
The state's general fund cash position is weak and the state is increasingly relying on short-term borrowing and deferring vendor payments to provide liquidity. Accounts payable at the end of the 2009 fiscal year were approximately $3.9 billion, equal to more than a three-month delay in payments. This compares to June 30, 2008, when there was $975 million in accounts payable. The state marketed $1 billion of GO notes in May and $1.25 billion of GO notes in August (both rated 'F1' by Fitch), which provided a partial solution to its short-term funding needs. Also, there are large cash balances, reported at $6 billion, in other state funds that now marginally exceed the current payables; any inter-fund borrowing or budget transfers would require legislative approval.
The state's net tax-supported debt is increasing and is now 5.1% of 2008 personal income. It is expected to continue to grow with a $31 billion capital plan that is likely to include significant borrowing, most of which would be backed by revenue sources outside of the general fund, including gaming revenues, and vehicle fees.
Longer-term challenges remain, in particular, continued significant growth in funding requirements to address the pension systems' large unfunded liabilities. As of June 30, 2008, the unfunded accrued actuarial liability was reported at $54.4 billion, resulting in a 54.4% funded ratio - down from 62.6% the prior year. While the ratio improved after a 2003 pension obligation financing and the benefit reforms of 2005, previous pension funding deferrals and recent market losses continue to constrain further funding improvement.
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 is not being affected as negatively by the national recession as some of these neighboring Midwestern states, it is now contracting faster than the national economy. Total non-farm employment declined 4.3% year-over-year in November 2009, versus the national contraction of 3.4%. November unemployment of 10.9% exceeded the national rate of 10%. Wealth levels remain high. Per capita income is 106% of the national average, thirteenth among the states.
The 'A-' ratings on the following bonds, which are based on the state's appropriation, are placed on Negative Watch:
Illinois Sports Facilities Authority, sports facilities bonds (state tax supported) series 2001 Chicago motor fuel tax revenue bonds, series 2003A, series 2008A, series 2008B
These rating actions reflect the application of Fitch's current criteria which are available at 'www.fitchratings.com' and specifically include the following reports:
--'Tax-Supported Rating Criteria', dated Dec. 21, 2009;
--'U.S. State Government Tax-Supported Rating Criteria', dated Dec. 29. 2009.
Additional information is available at 'www.fitchratings.com'.
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE.
Contacts:
Fitch Ratings, New York
Karen Krop, 212-908-0661
Laura Porter,
212-908-0575
or
Media Relations:
Cindy Stoller,
212-908-0526
Email: cindy.stoller@fitchratings.com