S&P Downgrades Illinois' Credit Rating

Standard & Poor's Ratings Services on Wednesday downgraded Illinois' credit rating by one notch to A from A-plus, citing the state's large budget imbalance and an $83 billion unfunded pension liability.

The action affecting the state's general obligation bonds comes less than two weeks after a special Illinois legislative session on pension reform ended without a solution to rein in costs for the state's five pension funds.

"The downgrade reflects the state's weak pension funding levels and lack of action on reform measures intended to improve funding levels and diminish cost pressures associated with annual contributions," said S&P analyst Robin Prunty in a statement.

Investors in the $3.7 trillion U.S. municipal bond market have been demanding higher yields for Illinois debt as the state's fiscal problems fester. Many states are struggling with budgetary constraints and pension liabilities, but the fiscal problems in Illinois predate the 2007-2009 recession and have continued to worsen.

It also keeps Illinois as the second lowest-rated U.S. state after California, which is rated A-minus by S&P.

S&P had warned in March that a potential multi-notch downgrade was in store if Illinois did not deal with its longstanding fiscal problems this year. The state was hit with only a single notch cut in its rating, affecting $27.5 billion of outstanding GO debt, but its outlook remains negative.

The lower rating also reflects Illinois' "continued financial weakness despite significant measures in the past two years to improve structural budget performance," Prunty said.

The ratings agency said its negative outlook reflects the potential for further erosion of the state's pension liability over the next two years and budget risks due to the Jan. 1, 2015, expiration of big income tax rate increases enacted in 2011.

Gov. Pat Quinn, who used the possibility of a credit rating downgrade to bring legislators into the unsuccessful Aug. 17 special session, said he will invite legislative leaders to meet on pension reform early next month.

"The only thing standing between Illinois and comprehensive pension reform is politics," the Democratic governor said in a statement. "We must put politics aside. Pointing fingers will not resolve this problem."

But Illinois Treasurer Dan Rutherford, a Republican, said pension reform may be on hold until after the Nov. 6 election.

"I think the election is the magic moment to bring along a timeline for a resolution," he said in a conference call with reporters.

Political squabbling and labor union protests helped unravel the special session. Powerful Democratic House Speaker Michael Madigan allowed his chamber to take up a bill curbing only the pensions of state lawmakers that was not called for a final vote.

A bipartisan bill passed by the Senate in May to ease pension costs for lawmakers and state employees "could have sent a positive message to the investment community that there is a bipartisan path toward comprehensive pension reform," said a statement from Democratic Senate President John Cullerton's office.

In a joint statement, Senate Republican leader Christine Radogno and House Republican leader Tom Cross called for immediate action to craft comprehensive pension legislation instead of a piecemeal approach.

S&P's A rating for Illinois matches the A2 rating following a downgrade by Moody's Investors Service in January. That left Illinois with the lowest rating among states Moody's rates. Illinois is also rated A by Fitch Ratings.

Moody's last week said Illinois' failure to improve its pension liability was a negative credit factor.

Illinois' so-called credit spread over Municipal Market Data's benchmark triple-A scale for 10-year debt narrowed earlier this week to approximately 145 basis points from 157 basis points as the state's still-hefty yields outweighed credit concerns for investors seeking to boost their returns, according to MMD, a unit of Thomson Reuters.

For California, which also has a sizable budget deficit and where a deal on pension reform was announced on Tuesday, the credit spread is less than half of Illinois' at 66 basis points.