* Considering the budget and the Supreme Court ruling on retiree health insurance, this news could’ve been much, much worse.

I have no idea whether Bruce Rauner’s openness to raising taxes contributed to only an outlook change rather than a ratings change, but the raters have to be breathing a sigh of relief now that both candidates for governor want new revenues after the income tax partially expires on January 1st…

Standard & Poor’s Ratings Services has revised its outlook on Illinois’ general obligation (GO) bonds outstanding to negative from developing and affirmed the ‘A-’ rating on the state’s GO bonds.

“The outlook revision follows the enactment of Illinois’ fiscal 2015 budget, which in our view is not structurally balanced and will contribute to growing deficits and payables that will likely pressure the state’s liquidity,” said Standard & Poor’s credit analyst Robin Prunty. “The outlook also reflects the implementation risk associated with recent reforms related to post retirement benefits,” Ms. Prunty added.

While legislation to reform pensions and other post employment benefits (OPEB) is considered positive, if the reforms do not move forward as planned we believe the significant fixed cost pressure associated with post retirement benefits will escalate. This risk is highlighted by the recent Illinois Supreme Court decision to reverse the trial court’s dismissal of the suit relating to statutory changes to the state’s health insurance premium subsidies, which was remanded back to the lower courts. It is uncertain what the lower court will ultimately decide but 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 Illinois Constitution.

Key factors supporting the ‘A-’ rating include what we view as Illinois’:

· Deep and diverse economy, which is anchored by the Chicago metropolitan statistical area;
· Above-average income levels;
· Substantial flexibility to adjust revenues, expenditures, and disbursements;
· Well-established and tested statutory priority of payment for debt service;
· 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; and
· Improved alignment of revenues and expenditures for fiscal years 2013 and 2014 with some steady reduction in payables. We expect this situation to reverse in fiscal 2015 absent budget adjustments.

Offsetting these generally positive credit factors are what we consider:

· Sizable and chronic accumulated budget-based deficits despite revenue-enhancement measures implemented in 2011and improved economic trends. While the deficit is reduced significantly, it remains significant relative to the size of the budget;
· A historically large generally accepted accounting principle general fund balance deficit;
· A large and growing unfunded actuarial accrued liability; and
· 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.

We consider Illinois’ economy to be broad and diverse, and the state’s income levels are well above average.

A negative outlook indicates that we could lower the rating during the two-year outlook horizon. The change reflects the enacted fiscal 2015 budget, which is not structurally aligned and we believe will contribute to growing deficits and weakened liquidity. Also factored into the negative outlook is the implementation risk associated with pension and OPEB reform measures. If the pension reform is declared unconstitutional or invalid, or implementation is delayed and there is a continued lack of consensus and action among policymakers on the structural budget gaps and payables outstanding, we believe there could be a profound and negative effect on Illinois’ budgetary performance and liquidity over the next two years and that this could lead to a downgrade. 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.

* Budget office react…

Governor 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 services. The legislature passed an incomplete budget and this is the predictable result.

Standard & Poor’s Wednesday maintained its A-minus rating on Illinois bonds but changed its outlook on Illinois from “developing” to “negative.”

Among S&P’s comments:

“Per capita personal income in 2013 was $46,780, or 105% of the U.S. average, ranking Illinois 15th nationally and first among the Great Lakes states.

“Structural budget alignment improved in fiscal years 2013 and 2014 due to economic and revenue recovery, revenue enhancement, and spending restraint and reform. A surplus was generated in fiscal 2013 that lowered the general fund deficit and payables outstanding on a budgetary basis.

“…additional expenditure reductions could be difficult to achieve after several years of cost cutting…”

While expressing concerns about implementing the state’s pension reform law given comments in a recent Supreme Court of Illinois case, S&P reaffirmed its favorable view of the state’s pension reform law: “We view the pension reform as a significant accomplishment that could lead to improved pension funding levels, greater pension plan sustainability, and improved prospects for budget stability.”

When Governor Quinn introduced his budget this Spring, S & P – like the other rating agencies – issued comments looking favorably on the governor’s proposed budget. Governor Quinn shared those comments with the legislature:

“The recommended budget could contribute to enhanced structural alignment due to less severe spending reductions needed to achieve balance…”