* From Fitch Ratings…

After two years, there are indications that Illinois may begin to address the issues that have led to an extended budget stalemate, credit deterioration, and Fitch Ratings placing the state of Illinois’ current ‘BBB+’ Issuer Default Rating (IDR) on Rating Watch Negative. Although the legislature did not take action during the “lame duck” session that ended with the installation of the new legislature today, the state senate has put forth a series of bills that have the potential to lead to a compromise that will resolve the impasse.

Fitch has stated that failure to enact measures that lead to ongoing budget balance would trigger a downgrade. The Senate bills reportedly include raising the state income tax and other revenue measures, debt issuance to reduce accumulated budgetary liabilities, pension reforms, aid to Chicago public schools, and non-budgetary reforms sought by the governor, including a freeze on property taxes, workers compensation reform, and some form of term limits. These proposals, if they proceed through the full legislature and are signed by the governor, have the potential to stabilize the Illinois IDR and related ratings if they lead to a structurally balanced budget and reduce accumulated budget liabilities. However, Fitch notes that previous signs of progress have not always come to fruition. Fitch will assess any legislation enacted by the state to determine if it provides permanent, comprehensive solutions to the budget stalemate and sets the state on a path toward ongoing budgetary balance.

Fitch has previously indicated that the Rating Watch would be resolved by the end of January. The expected timing of Fitch’s review is unchanged.

I really doubt this will be resolved by the end of January, but we’ll see.

* Meanwhile, from Moody’s…

While unfunded pension liabilities will continue weighing on the City of Chicago’s (Ba1 negative) credit profile, plans to significantly increase contributions with higher taxes is a favorable departure from prior funding practices. However, the liquidity crisis at Chicago Public Schools (CPS – B3 negative) is worsening amid a continued budget impasse at the state level, Moody’s Investors Service says in two new research reports released today.

While Chicago and CPS are legally separate entities with distinct credit profiles, they share the same tax base and have some overlapping governance.

In “City of Chicago: Frequently Asked Questions,” Moody’s says despite the city’s expanding economy, revenue growth, and healthy liquidity, its pension burden is likely to remain among the highest of any rated, major local government for many years.

“While Chicago’s recent tax increases will provide revenue to significantly increase pension funding, the city’s unfunded pension liabilities exceed seven times its revenue and are projected to grow for at least 15 more years,” says Matt Butler, Vice President of Moody’s.

Moody’s says there is a limit on Chicago’s ability to raise taxes on its citizens and businesses, because each increase tempers the appetite for further tax hikes that could be needed. Within the last two years, there has been numerous tax increases by overlapping governments, including Chicago, CPS and Cook County, IL (A2 stable), with new revenue slated for funding pensions instead of government services.

In a separate report, “Chicago Public Schools: Frequently Asked Questions,” Moody’s states CPS’ fiscal pressures are intensifying due to depletion of reserves following years of imbalanced operations, unrealistic budget assumptions, and escalating pension costs.

“CPS’ deteriorating credit profile reflects years of budget imbalance which have completely drained operating reserves, leaving the district with minimal protection against further budget pressures,” said Naomi Richman, Managing Director of Moody’s.

Coinciding with the sharp drop in fund balance, CPS’ liquidity has fallen considerably and the district has turned to issuing short-term tax anticipation notes to support its operations. Its recent $730 million offering is strictly for capital improvements and cannot be used for operating expenses.

CPS has also assumed material growth in state aid that for the last two years has not materialized, worsening its budget imbalance. Rising pension costs have also exacerbated CPS’ finances and these costs will continue to grow annually.

Moody’s says CPS could consider more difficult options to address its finances should the State of Illinois (Baa2 negative) be unable or unwilling to provide additional relief: levy for debt service on GO alternate revenue bonds, stop making employer pension contributions, or seek state authorization to file for Chapter 9 bankruptcy.

As CPS’ credit deteriorates, it could have an impact on the city’s credit profile. CPS is integral to Chicago’s economy and tax base, and CPS’ budget pressures could impair the city’s ability to raise revenue.

Should CPS levy for debt service, the subsequent property tax increase for Chicago residents and businesses could weaken the city’s political and practical ability to increase tax revenues in the future.