* From Fitch…

Fitch Ratings has placed the ‘A’ rating on the general obligation (GO) bonds of the State of Illinois on Rating Watch Negative. The rating action affects approximately $26.2 billion in outstanding GO bonds of the state. Ratings linked to the state GO rating, listed at the end of this release, have also been placed on Rating Watch Negative.

The Rating Watch Negative reflects the ongoing inability of the state to address its large and growing unfunded pension liability, most recently through the failure to pass pension reform in the ‘lame duck’ portion of the 97th general assembly legislature that ended on Jan. 8. Fitch believes that the burden of large unfunded pension liabilities and growing annual pension expenses is unsustainable. The Rating Watch Negative will be resolved after an assessment of the extent to which the state takes action within the next six months that limits the impact of pension payments on the budget while bolstering pension funded levels. Failure to achieve meaningful results would lead to a downgrade of the rating.

Illinois’s long-term liabilities, particularly pension liabilities, are very high for a U.S. state. As of June 30, 2012, the unfunded actuarial accrued liability was reported at $94.6 billion, resulting in a 40.4% reported funded ratio. This large unfunded pension liability is despite the issuance of pension obligation bonds and passage of bipartisan comprehensive pension reform affecting new employees in March 2010.

Annual pension funding requirements have been increasing significantly and growing pension payments are crowding out other expenditure growth and absorbing revenue growth. Pension payments from the general fund increased $965 million to $5.1 billion in 2013, an increase of 23%, reflecting in part the use of more conservative investment return assumptions. Fitch notes that even these large payments, which consume a well-above-average percentage of the state’s general fund budget, are based on statutory formula and are below the actuarially required contribution (ARC).

Several reform proposals have been presented by the governor and various legislators that would adjust benefits for existing employees, increase employee contributions, limit cost of living increases, and increase the retirement age. Other proposed structural changes to the pension program include shifting some responsibility for employer contributions to school districts and state universities and establishing a 30-year funding schedule based on the ARC that aims to reach 100% funding by 2042. Under current statute, annual contributions are designed to reach 90% funding by 2045. Fitch believes that enactment of reform is critical to the long-term stability of the state’s fiscal position, although legal protection of pension benefits is particularly strong in Illinois and Fitch expects any changes to be litigated.

The ‘A’ rating on Illinois’s GO bonds reflects the state’s broad based and diverse economy offset by the challenges presented by a budget that is balanced through significant temporary tax increases, high long-term liabilities including pensions, and a large accounts payable backlog that reflects the payment deferrals the state used to manage its operating deficit through the downturn.

The state’s GO bonds benefit from an irrevocable and continuing appropriation for all GO debt service, and continuing authority and direction to the state treasurer and comptroller to make all necessary transfers from any and all revenues and funds of the state. The state funds debt service in advance by setting aside 1/12 of principal and 1/6 of interest every month for payments due in the ensuing 12 months. [Emphasis added.]

That’s not nearly as bad as it could’ve been, but there are other ratings agencies.

*** UPDATE 1 *** From the governor’s office…

“The Fitch report speaks for itself. This should be required reading for every member of the new General Assembly. We have an emergency and it’s not going away.”

*** UPDATE 2 *** Sun-Times…

The move may not have a direct impact on the state’s finances and posts “very minimal risk” to existing state bond holders, but it ultimately could foreshadow higher borrowing costs the next time Illinois goes to market for long-term loans, a company spokeswoman said.

“The immediate result, to be honest, is probably nothing. It doesn’t affect what they’re doing on a day-to-day basis,” Fitch analyst Karen Krup told the Chicago Sun-Times. “But for direct impact on the state, when they try to go to market the next time, there could be implications on borrowing costs.”

*** UPDATE 3 *** From Leader Tom Cross…

“Fitch’s downgrade of our bond rating is embarrassing and may cost the state more money—money that we clearly do not have. How many more times do we have to be downgraded to prompt action in the General Assembly? I have worked and will continue to work with other members in the House and Senate to pass meaningful pension reform.”

*** UPDATE 4 *** Treasurer Rutherford…

“Fitch Ratings announced that the agency has placed Illinois’ general obligation bonds rating on negative watch. Fitch decided to do this because of the state’s inability ‘to address its large and growing unfunded pension liability.’ The next step could potentially be the downgrade of the state’s credit rating from Fitch. Failure to enact pension reforms will eventually bring Illinois to its financial breaking point, and it will be worse than any fiscal calamity we have seen thus far in this state. Our state’s credit rating cannot afford to take another hit.”

“Furthermore, it has now been two years since Governor Pat Quinn’s 66% income tax hike was passed, and though it was billed as a measure that would help solve the state’s financial problems, money matters in Illinois have only gotten worse. On January 11, 2011, the state’s backlog of bills was reportedly $8.5 billion. Today the state owes vendors nearly $9 billion dollars.”

“In the past decade, the state’s bonded debt has nearly tripled. Illinois’ debt is colossal and growing– our debt obligations now exceed $200 billion. It is estimated that the failure to address the state’s pension liability is costing the state at least $17 million per day. It is beyond irresponsible to let this continue. The state needs to reign in the pension escalation and not use long-term borrowing as a ‘solution’ to this problem.”

Also, the governor was asked about Fitch’s move today. Raw audio…

Click to listen

*** UPDATE 5 *** Rep. Elaine Nekritz and Sen. Daniel Biss…

“This announcement just confirms what we have feared and warned about: our state finances are in real trouble. We must act quickly and decisively to address the pension problem and send a strong message that Illinois is serious about getting its fiscal house in order for the long term.”