CHICAGO - A lower court ruling throwing out Illinois' pension reforms isn't expected to trigger any immediate legislation or negative credit action, as all eyes turn to the Illinois Supreme Court.

Sangamon County Circuit Court Judge John Belz on Friday voided the pension legislation saying the cuts violated the state constitution's clause that protects pension benefits from impairment or diminishment, agreeing with the arguments laid out by unions and employees and retirees who filed lawsuits challenging Public Act 98-0599.

The state, knowing a legal challenge loomed, didn't build any savings on pension contributions from the pension into its fiscal 2015 budget that runs through June 30, so there's no immediate fiscal impact. It's also long been clear that the state high court would have the final word on the reforms approved last December.

The rating agencies are taking a cautious approach.

Standard & Poor's wrote in a special bulletin published late Friday that the state's A-minus general obligation rating and negative outlook would hold.

All three rating agencies assign a low single-A rating to the state's GOs, the lowest among states, and a negative outlook. The state's $111 billion of unfunded obligations have driven the state's steep credit deterioration in recent years.

"We cited the legal challenges to the pension reform legislation and the associated implementation risk …when we revised the outlook on the state to negative from developing, and we will continue to monitor the legal process relating to the pension legislation," Standard & Poor's wrote. "More importantly, from a credit perspective, savings from the pension reform are not included in the fiscal 2015 budget."

Moody's Investors Service hasn't yet factored the benefits of the reforms into its ratings assessment. "We recognized that it was positive that the state had reached a consensus on a strategy but we also realized even with enactment of the law, implementing the reforms was a different matter given the constitutional protections," analyst Ted Hampton said.

Hampton added the "court's ruling doesn't alter our view on the credit, but it is a negative development to the extent it adds more weight to the notion that the 2013 reforms do violate the pension protections." The latest negative follows a ruling from the high court justices over the summer finding that retiree healthcare benefits are protected.

In his ruling, Belz rejected the state's defense that it acted within its police and sovereign powers to alter its contract with retirees due to the state's fiscal emergency. Belz said the state did not make the case that such powers were sufficient to ignore the "plain language" of the pension clause protecting annuities. Belz made permanent a temporary injunction banning the state from implementing the changes and Attorney General Lisa Madigan announced an immediate appeal of the decision to the state's high court.

While the decision's immediate impact on ratings is muted, it could fuel volatility in secondary trading levels for Illinois paper and other credits like Chicago, market participants said.

"I would say that it makes sense that spreads could turn wider for a while," said Triet Nguyen, a managing director at New Oak.

The ruling is considered a setback for the state and offers a significant glimpse into a judge's interpretation of the arguments and constitutional law that some believe foreshadows how the high court will rule. An adverse ruling would throw the state's efforts to stabilize its financial foundation in a tailspin.

"From a credit standpoint, Standard & Poor's views the pension reform as a significant accomplishment that could lead to improved funding levels, greater plan sustainability, and improved prospects for budget stability," analysts wrote.

Fitch Ratings also said it had not factored in savings from the pension reforms in its rating assessment due to the legal challenge that was always expected to go to the state's high court and state's decision not to incorporate savings in fiscal 2015. "The ruling is not an immediate credit concern," said analyst Karen Krop. "The state's budget is a more immediate concern." The state's fiscal 2015 relies on one-shots and falls to cover a full year's spending demands as lawmakers failed to approve an extension of the 2011 income tax rates that partially expire Jan. 1

Other local governments, too, are watching closely. Chicago - saddled with $19 billion of unfunded obligation that have also driven its credit deterioration -- won an overhaul of two of its four pension funds earlier this year, but negotiations with its police and firefighter funds are on hold.

The unions want to see how the state reforms play out as an unconstitutional finding would them greater bargaining leverage.

If the ruling holds, it will fall on Gov.-elect Bruce Rauner, a Republican, and a Democratic led General Assembly to find a new fix for a pension system that's just 39.3% funded. Rauner has said he believed the changes were unconstitutional but he has not offered up an alternative. Few lawmakers have weighed in on an alternative as the state hopes to argue it had no other choice but to alter pension benefits given its budgetary, liquidity and pension woes it has called a "crisis."

The Center for Tax and Budget Accountability has advocated for a re-amortization of the current 1995 contribution schedule and funneling an additional $1 billion that now goes to retire pension related borrowing. The state could also lower the 90% funded ratio target under the 1995 schedule. The state could negotiate with unions lower cost-of-living increases, a big driver of the unfunded obligations, in exchange for less costly benefit enhancements. The state also could shift some costs for teachers' pension off to local districts and universities.

The overturned legislation would limit COLAs, cap pensionable salaries and raise the retirement age for some, while cutting employee contributions by 1%, shifting contribution calculations to a more actuarially sound method, and giving the pension funds enforcement rights over state payments.

The changes would shave about $145 billion off state payments in the coming decades, including $1.1 billion in fiscal 2016, while bringing the system full funding in 30 years. About $21 billion would be pared from the unfunded obligations' tab.

House Speaker Michael Madigan led the charge after rejecting efforts from Senate President John Cullerton to push through a package with more limited savings of $57 billion achieved by asking employees to voluntarily accept cuts in exchange for preserving their retiree healthcare subsidies. The plan had the support of some unions.

Cullerton believed direct cuts would not withstand a constitutional challenge but did not attempt to block Madigan's plan. The state lost retiree healthcare as a bargaining chip when the high court ruled the benefits are protected.

Moody's in a special commentary issued late Monday noted the deep strains of the state's pension liabilities. The agency last week announced Illinois' fiscal 2013 adjusted net pension liability to revenue was the highest of all states at 268%. The median for all 50 states is 60%. "The state's negative outlook indicates the possibility that factors such as further growth in the state's pension liabilities will drive the rating lower still. Inauguration of a With a new governor starting office on January 12, the new administration's ability to formulate strategies to manage its retirement benefit liabilities will be a key factor in future rating decisions," Moody's said.

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