Illinois faces an increased risk of credit rating downgrades after the 2013 pension overhaul was struck down by the Illinois Supreme Court as unconstitutional. Illinois already has the lowest credit rating among U.S. states of A3/A-/A- by Moody’s, S&P and Fitch.

Standard & Poor’s placed the state’s rating on CreditWatch with negative implications following the court ruling, stating that it expects to decide on the rating within three months. Moody’s and Fitch both maintain a negative outlook for their Illinois ratings.

Illinois faces a significant structural imbalance with more than a $6 billion operating deficit for the next fiscal year and a severe pension funding shortfall (39.3% funded). The state has regularly used payment deferrals to manage its operating cash fund. Illinois has long term weak management practices reflected in pension underfunding, bill payment delays and chronic GAAP-basis negative fund balances.

The 2013 pension law overturned by the court would have reduced retirement costs by shrinking cost-of-living increases for retirees, raised retirement ages for younger employees and capped the size of pensions. The overhaul was expected to save $145 billion over 30 years. The ruling by the court stated that under the state constitution benefits promised as part of a pension plan for public workers shall not be diminished or impaired.

Illinois Governor Bruce Rauner who took office in January is expected to propose a new pension overhaul plan which would require amending the state constitution. Pension benefits already earned are expected to be preserved under the plan while unearned benefits would be transferred to a new 401K-type plan. The plan includes asking voters to approve the constitutional change in 2016 that removes the language that protects retirement payments.

The Illinois Supreme Court’s overturning of the statue also limits the City of Chicago’s options for curbing growth in its own unfunded pension liability. Simply, the State cannot afford to support an ailing City of Chicago.  Consequently, Moody’s downgraded Chicago’s general obligation (GO) debt two notches to Ba1, causing the rating to fall to high yield yesterday.  The rating agency continues to have a Negative Outlook for the rating since it expects Chicago’s credit challenges will continue, making future rating actions appear likely.  AAM continues to believe the risks are too high to justify municipal investments in the State of Illinois and the City of Chicago.  The City of Chicago’s 10 year bond spreads widened 100 basis points after the announcement of the downgrade.

Hugh R. McCaffrey, CFA
Senior Analyst, Corporate Credit


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