Fitch Ratings has assigned an 'A' rating to the following general obligation (GO) bonds of the State of Illinois:
--$3.7 billion GO bonds, taxable series of February 2011.
Fitch has also affirmed the rating on approximately $24.5 billion of outstanding GO bonds of the State of Illinois and revised the Outlook to Stable from Negative. In addition, the ratings related to the state based on its appropriation are affirmed at 'A-' and the Outlook revised to Stable from Negative, as noted at the end of this commentary.
The bonds are expected to sell via negotiation on Feb. 17, 2011.
RATING RATIONALE:
--The Outlook revision to Stable from Negative
reflects the steps the state has taken to address its budget imbalance
through a sizeable increase in both corporate and personal income taxes.
Following several years during which the state was unwilling to take
action to restructure its budget to achieve balance and increased
reliance on borrowing to close budget gaps, the tax increase and enacted
spending limits close a significant portion of the structural gap in the
state's budget through fiscal 2014.
--Because the tax increases are
temporary, the state will need to find a more permanent solution to the
mismatch between spending and revenues. Further, despite the significant
increase in tax revenues, the state is expected to continue to rely on
one-time revenues, including the expected use of debt financing for
operations, in fiscal 2012.
--The state must still take action to
address its accounts payable backlog, which totaled $6.4 billion at the
end of fiscal year 2010, equal to 23% of general fund resources.
Proposed borrowing to finance the backlog has not yet been authorized by
the Illinois legislature. While the borrowing would add to the state's
growing debt load, the ability of the state to bring its payment
obligations more current in a timely manner will be limited without the
borrowing.
--The state's debt burden is above average and rising
and additional borrowing is expected under the $31 billion capital plan.
Significant borrowing is expected to retire the unfunded liabilities
accumulated through the past two to three years of operating deficits.
--Despite
the issuance of pension obligation bonds, there is a large unfunded
pension liability. The state passed comprehensive pension reform (March
2010) that will lower its future pension liability but will not have a
significant near-term affect on financial operations.
--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.
KEY RATING DRIVERS:
--Ability to achieve and sustain balanced
operations going forward, including limited reliance on non-recurring
solutions.
--Addressing accounts payable backlog.
SECURITY:
Direct general obligation, full faith and credit of the
state of Illinois.
CREDIT SUMMARY:
The Outlook revision to Stable from Negative
reflects the significant revenue raising action taken by the state to
realign its financial operations. The increase in tax revenue, in
conjunction with newly enacted hard spending limits, provide a means for
the state to return to budgetary balance over the next three fiscal
years. The affirmation of the rating at 'A' recognizes the challenges
that remain, including enacting a plan to reduce the outstanding
accounts payable balance, and achieving structural balance without the
use of debt financing to support operations, particularly in light of
the temporary nature of the tax increases.
The state's actions follow several years during which it has been unwilling to take comprehensive action to restructure its budget either through revenue raising or spending reductions. During this time, the state has instead relied on borrowing to close budget gaps and has increasingly delayed payments to service providers, vendors, and local governments, resulting in an accumulation of over $6.4 billion in accounts payable, as of June 30, 2010, equal to 23% of state resources. The temporary tax changes are expected to generate over $7 billion annually, a 25% increase in ongoing revenue, which will largely close the operating deficit. The tax increases have been coupled with new spending limits which dictate hard dollar caps on appropriations for operations. While the new limits increase approximately 2% per year, this growth is expected to be more than absorbed by mandatory increases in pension funding and Medicaid spending, resulting in a need to make reductions elsewhere in discretionary spending.
While the actions taken to date are significant positive steps, challenges remain. The Governor's projected spending plan, which incorporates the additional tax revenues and spending limits, continues to rely on borrowing for operations in fiscal 2012 to accommodate the loss of federal stimulus funds. Further, the tax increases are temporary and will begin to phase out in 2015. Even if the state has achieved budget balance by that point, it will once again be faced with a significant budget balancing decision to make severe expense reductions that it has been unwilling to make up to this point, identify new revenues, or make permanent the tax increases. In addition, the state's ability to reduce its accounts payable backlog in a meaningful way relies on debt issuance that has yet to be authorized.
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 were repeatedly delayed. Faced with reduced revenues and an aversion to broad based tax increases, the fiscal year 2010 enacted budget relied heavily on non-recurring revenues, particularly the use of debt to finance current operations. Taking into account the pension payment that was effectively covered by a $3.5 billion GO issuance rather than general fund resources, the budgetary deficit grew to approximately $6 billion, 22% of general fund resources.
The fiscal 2011 budget, enacted in July 2010, continued to push solutions out to the future; relying heavily on borrowing and deferring payment to those reliant on the state. While the enacted budget for fiscal year (FY) 2011 did include $1 billion in spending cuts, it left a $5.9 billion funding gap (21.3% of FY 2011 expected revenues) to be closed by issuing bonds to fund the annual pension payment (the current offering), interfund transfers, and securitization of tobacco settlement revenues, and carried over $6 billion in accounts payable through another fiscal year. The tax increase will generate approximately $2.8 billion in additional revenue for fiscal 2011, allowing the state to improve its perennially weak cash position, reduce its use of interfund borrowing, and begin to pay down the accounts payable backlog.
The state's net tax-supported debt is increasing and is now 6.3% of 2009 personal income, a moderate but above average level. The additional borrowing assumed in the Governor's spending plan would push the ratio closer to 9%, a high level. Further, the state's $31 billion capital plan includes significant borrowing, most of which would be backed by new revenue sources, including gaming revenues, and vehicle fees.
The state faces continued significant growth in funding requirements to address the pension systems' large unfunded liabilities. As of June 30, 2010, the unfunded accrued actuarial liability was reported at $75.7 billion, resulting in a 45.4% funded ratio, a level which reflects the use of five-year smoothing. It is expected that the recent passage of comprehensive pension reform, in March 2010, which establishes a two-tier pension system for public employees, raises the retirement age, and scales back growth in benefits, will significantly reduce the state's future liabilities. The state's ability to address what has been a long-standing credit weakness and on-going funding challenge is a credit positive.
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 recent 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 4.3%. Modest growth has resumed with year-over-year job gains of .6% as of November 2010, similar to the national rate of .7%. November unemployment of 9.8% brought the state's unemployment rate below the national rate for the first time in several years. Wealth levels remain high. Per capita income is 105% of the national average, 14th among the states.
The 'A-' ratings on the following bonds, which are based on the state's appropriation, are affirmed; the Outlook is revised to Stable from Negative:
--Illinois Sports Facilities Authority, sports facilities bonds (state
tax supported) series 2001;
--Chicago motor fuel tax revenue bonds,
series 2003A, series 2008A, series 2008B.
Applicable Criteria and Related Research:
--'Tax-Supported Rating
Criteria', dated Aug. 16, 2010;
--'U.S. State Government
Tax-Supported Rating Criteria', dated Oct. 8, 2010.
For information on Build America Bonds, visit 'www.fitchratings.com/BABs'.
Applicable Criteria and Related Research:
Tax-Supported Rating
Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=548605
U.S.
State Government Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=564546
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