CHICAGO - Illinois suffered a setback Wednesday when Standard & Poor's revised its outlook on the state's A-minus rating to negative, reflecting analysts' dim view of the state's new budget and concerns over whether retirement benefit reforms will withstand a legal test.
Standard & Poor's analyst Robin Prunty said the rating agency is concerned the budget "will contribute to growing deficits and payables that will likely pressure the state's liquidity."
The outlook also reflects the implementation risk associated with recent reforms related to postretirement benefits, she wrote.
The rating was affirmed at A-minus.
The rating agency had shifted the state's outlook to "developing" in December after lawmakers passed a sweeping pension reform package designed to stabilize the retirement system saddled with $100.5 billion of unfunded obligations.
Many viewed that outlook shift as a positive for the state's credit, signaling that it had stabilized, although any positive credit movement would have required passage of a structurally sound budget and a favorable court outcome for the pension reforms.
Lawmakers in May refused Gov. Pat Quinn's request to make permanent the state's partially expiring 2011 income tax hike, or to cut spending to reflect the expected $1.8 billion drop in revenues in fiscal 2015, which began July 1.
The legal challenge to the pension reforms is still pending, but a July 3 Illinois Supreme Court ruling ascribing strong state constitutional protections to retiree healthcare benefits has heightened concern over whether the pension reforms will withstand the challenge. Both the pension overhaul and the retiree healthcare changes would cut annual state costs.
"If the reforms do not move forward as planned we believe the significant fixed cost pressure associated with postretirement benefits will escalate. This risk is highlighted by the recent Illinois Supreme Court decision," Standard & Poor's said. That case now returns to the lower court which must decide whether the changes impaired retiree benefits.
While it's unclear how the lower court will rule, the Illinois Supreme Court was clear in its opinion that the health insurance subsidies paid by the state for retiree health care are a benefit derived from membership in a state pension plan and therefore subject to the state constitution, Standard & Poor's said.
"If pension reform moves forward, and the state takes credible action to achieve structural budget balance over the next two years, we could revise the outlook to stable," analysts said.
Standard & Poor's warned in April that the state's credit direction hung in the balance as lawmakers worked on the budget.
Quinn's administration issued a statement Wednesday indicating little surprise in the ratings action.
"Gov. Quinn was clear with legislators this year that bond rating agencies would look with disfavor on a budget that did not contain enough revenue to cover a full year of the state's needs on education, public safety and human service," said Quinn's deputy budget director Abdon Pallasch. "The legislature passed an incomplete budget and this is the predictable result."
Lawmakers are expected to revisit the tax issue after the November election.
The state's rating is supported a deep and diverse economy, anchored by the Chicago metropolitan area; above-average income levels; substantial flexibility to adjust revenues, expenditures, and disbursements; and well-established and tested statutory priority of payment for debt service, the rating agency said.
Challenges include sizable and chronic accumulated budget-based deficits despite the 2011 income tax hikes; a large and growing unfunded actuarial accrued liability; and a moderately high and growing debt burden due.
A negative outlook indicates the state could face a downgrade during a two-year outlook horizon. The state carries equivalent ratings of A-minus and A3 from Fitch Ratings and Moody's Investors Service, making it the lowest rated state. Both also assign a negative outlook.
