Illinois on the downward slope

January 28, 2013

The state of Illinois was placed in the lower investment grade class last week when Standard & Poor’s downgraded the state to A- with a negative outlook.



Standard & Poors

A  [negative watch]

A2  [Negative outlook]

A –  [Negative outlook]

On a market-based scale, the Fitch (A) and Moody’s (A2) ratings for Illinois are considered equivalent, while Standard & Poor’s is considered one notch lower. But more importantly, all the raters have a “negative watch or outlook” on the state. This means that it could be downgraded again. The ship is taking on water.

There are several reasons why raters view Illinois so negatively. The state’s spending is way out of line with its revenue and its deficit is about 25 percent of its annual budget. Unlike the federal government, Illinois cannot endlessly issue new bonds to cover annual shortfalls. Instead, the state simply delays paying its bills from year to year. From S&P’s rating action:

The combined deficit now totals $8.8 billion ($5 billion general fund and $3.8 billion Section 25 liabilities) or 26 percent of general fund expenditures and transfers.

Large unfunded liability for its five pensions, which stood at $95 billion (40.4 percent funded) at fiscal year-end 2012. This is in addition to a large $33.3 billion UAAL for Illinois’ other postemployment benefits, which continue to expand.

A moderately high and growing debt burden due to debt issuance for current pension contributions in fiscal years 2010 and 2011, and the approved long-term capital program.

Basically, the state is massively overspending every year, has poorly funded pension systems and has been borrowing to make contributions to pensions and other projects. The debt that the state is carrying (about $33 billion) is pretty high and growing. It’s a fiscal dead-end. The biggest revenue issue is that the big income tax increases which were voted on two years ago to close deficits didn’t work, and they begin to expire in 2015. This will leave a gargantuan hole in the budget.

Because of these problems, bond markets are charging the state a large premium to issue its debt. Here are the current 10-year borrowing rates for Illinois and other big, diversified states. Note that Illinois is paying about 95 basis points (0.95 percent) more than California, although they have about equivalent credit ratings:

The credit rating agencies want pension reform, which has been two years in the works, to be completed. Illinois is out of tricks to fund it creatively (such as issuing bonds to make the required contributions). Sadly for the state, these problems were decades in the making. There are no short-term fixes. Illinois is on a downward slope and it’s going to be hard to switch directions.


Moody’s revises State of Illinois’ rating outlook to negative from stable; general obligation rating affirmed at A2

Standard & Poor’s: Summary: Illinois; General Obligation

Fitch rates $500MM Illinois GO bonds ‘A'; Remains on rating watch negative

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