S&P Global Ratings lowered its rating on Illinois' general obligation (GO) bonds to 'BBB' from 'BBB+'. S&P Global Ratings also lowered its rating on the state's appropriation debt to 'BBB-' from 'BBB' and its rating on the state's moral obligation debt to 'BB' from 'BB+'. As a result of the downgrade on the state's GO debt, we also lowered our rating on the series 2003 B-2 GO variable-rate bonds to 'A+/A-1'
from 'AA-/A-1' based on the application of our joint support criteria. The outlook on all ratings is negative.
"The downgrade reflects our view of continued weak financial management and increased long-term and short-term pressures tied to declining pension funded levels," said S&P Global Ratings credit analyst John Sugden. In our view, the extremely weak market returns for Illinois pension systems will contribute to substantial increases in the state's statutory contribution, in addition to the contribution increases resulting from several changes to assumed rates of return.
At the same time, S&P Global Ratings assigned its 'BBB' rating and negative outlook to Illinois' GO refunding bonds, series of October 2016 and GO bonds series of November 2016. The bonds are secured by the full faith and credit pledge of the state and are issued under the state's General Obligation Bond Act. Under provisions of the fiscal 2017 budget stopgap measure, the legislature provided some flexibility under its debt issuance parameters to allow the state to refund debt to achieve greater savings. The refunding is expected to provide approximately $100 million in net present value savings and to shorten the final maturity by one year relative to the refunded bonds. Due to legal restrictions, savings are expected to be taken primarily over the first two years with declining savings over the remaining maturities with the exception of the last year in which savings increase due to the shortened maturity. The series of November 2016 bonds are new money and we expect bond proceeds to be used to fund capital projects under the state's capital program.
The 'BBB' rating reflects our view of the state's:
• Long history of structural imbalance and a governmental framework that limits the state's ability to curb its spending in absence of an adopted budget;
• Top leadership's highly polarized views on how to address Illinois' fiscal imbalance, which has left the state without a fully adopted budget for a second year, and which continues to impede progress on fiscal realignment;
• Large projected operating deficit of approximately $6 billion, which could lead to pressure on liquidity and increased payables that could rise to up to $11 billion by fiscal year-end 2017, absent a budget compromise;
• Large net pension liability for its five pensions systems, which stood at $116 billion (40.2% funded) on a Governmental Accounting Standards Board (GASB) Statement 68 basis, and which is expected to increase based on weak market returns over the past two years with limited likelihood of pension reform following the May 8, 2015 ruling that the state's pension reform efforts are unconstitutional and confirming the pension protections contained in Illinois' constitution; and
• Moderately high debt burden.
Partial offsetting these weaknesses is our view of:
• Well-established priority of payment for debt service established by statute;
• Ability to adjust disbursements to stabilize cash flow and to access substantial amounts of cash reserves on deposit in other funds for debt service, if needed, and for operations if authorized by statute;
• Deep and diverse economy, which is anchored by the Chicago metropolitan statistical area, but is expected to lag the nation in growth over the next five years;
• Above-average income levels; and
• Substantial ability, albeit current lack of agreement on how to adjust revenues, expenditures, and disbursements.
The negative outlook reflects our view that absent significant measures to achieve structural balance and contain fixed cost growth in the near future, the state's practical capacity to improve its finances could greatly diminish and, with it, its credit quality.
We could lower our rating should the state continue to demonstrate a lack of ability or willingness to adopt a long-term structural budget solution that also incorporates a credible approach to its long-term liabilities. It also reflects our view that Illinois' ability to maintain adequate debt-paying capacity is becoming increasingly challenged the longer the political gridlock in Springfield plays out. The negative outlook also reflects our view that the state is particularly susceptible to any unanticipated economic stress or revenue underperformance. Although we don't foresee this in the immediate
future, challenges to the state's debt payment priority could emerge should liquidity dwindle to the point where it affects the state's ability to provide essential services. Additional downside pressures on the rating include the potential need to make accelerated debt payments on its variable-rate debt should the state fail to extend the letters of credit or face a swap termination event due to a rating trigger.
We could revise the outlook to stable should Illinois' elected leaders demonstrate the ability to negotiate and agree on a revenue and spending package that makes significant and long-lasting improvements to the state's structural budget alignment. Given the long-term challenges that the state must address to stabilize its fiscal condition, including addressing its management of its long-term liabilities, demonstrating the ability to compromise and reach consensus is important from a credit standpoint.
We don't anticipate a positive rating action prior to the state establishing a trend of improved financial metrics and substantially reduced long-term liabilities.
