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Fitch Warns Illinois to Act on Pensions or Face Downgrade

JAN 11, 2013 5:59pm ET
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CHICAGO — Fitch Ratings put Illinois on notice Friday that its single-A general obligation bond rating faces a downgrade absent any action to solve its pension funding crisis.

Fitch’s move to put the state’s GO credit on negative watch was the first rating agency reaction to the General Assembly’s failure to overhaul the pension system during a lame-duck session.

Illinois lawmakers adjourned Jan. 9 despite pressure from Gov. Pat Quinn, civic and business groups, and the public to enact reforms that would chop the state’s $95 billion of unfunded liabilities, funded at a ratio of just 40.4%, the worst of any state.

Escalating retirement payments are straining state coffers and crowding out spending on education, infrastructure, and health and human services.

“Fitch believes that the burden of large unfunded pension liabilities and growing annual pension expenses is unsustainable,” said the report from lead Illinois analyst Karen Krop.

The state’s burden continues to build even though the state borrowed $10 billion to bring down its obligations in 2003 and passed legislation in 2010 cutting benefits for new employees.

“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,” it read.

If downgraded, Illinois would join California at the A-minus level. Puerto Rico is rated BBB-plus. All other states are rated in the double-A category, Fitch noted.

“The Fitch report speaks for itself,” said Abdon Pallasch, assistant budget director in the Quinn administration. “This should be required reading for every member of the new General Assembly. We have an emergency and it’s not going away.”

The action affects $26.2 billion of state GO debt. In conjunction, Fitch put the A-minus rating of on $438 million of Illinois Sports Facilities Authority state-tax supported bonds on negative watch.

The state has no imminent plans to borrow, but could be in the market later in the first quarter, officials said. Illinois’ credit woes are expected to reverberate to local governments, schools, public transit agencies and others as investors demand what’s been dubbed an Illinois penalty for their location in the fiscally strapped state.

Moody’s Investors Service last month revised its outlook on Illinois’ A2 general obligation rating to negative from stable. Standard & Poor’s rates Illinois’s $32.8 billion of debt A with a negative outlook.

Pension payments rose by nearly $1 billion to $5.1 billion in the $34 billion fiscal 2013 budget and will rise by a similar amount in the next state budget.

“Annual pension funding requirements have been increasing significantly and growing pension payments are crowding out other expenditure growth and absorbing revenue growth,” Fitch said.

Several reform proposals advanced during the lame-duck session but none that drew sufficient support for leaders to bring them up for a vote. The plans rely on benefit cuts, higher contributions, and-or gradually shifting teacher pension payments to local districts. The new General Assembly was sworn in Wednesday to begin the process all over again.

The rating is supported by the state’s broad based and diverse economy but is challenged by its pension and debt obligations, a massive bill backlog, and the expiration in 2015 of a portion of a a state income tax hike.

Any reforms likely face litigation and may not have an immediate effect, Fitch noted. The state constitution affords strong contractual rights to pension benefits which cannot be “diminished” or “impaired.” The Democratic sponsors of a House plan, Rep. Elaine Nekritz and Sen. Daniel Biss, said: “We must act quickly and decisively to address the pension problem and send a strong message that Illinois is serious.”

The Democratic sponsors of a House plan -- Rep. Elaine Nekritz and Sen. Daniel Biss – said in a statement on the Fitch action: "This announcement just confirms what we have feared and warned about: our state finances are in real trouble. We must act quickly and decisively to address the pension problem and send a strong message that Illinois is serious about getting its fiscal house in order for the long term."

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