Summary:

Illinois; General Obligation

Primary Credit Analyst: Robin Prunty L, New York (1) 212-438-1000; robin_prunty@standardandpoors.com Secondary Contact: John Sugden A, New York (1) 212-438-1000; john_sugden@standardandpoors.com

Table Of Contents
Rationale Outlook Related Criteria And Research

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Summary:

Illinois; General Obligation

Credit Profile
US$500.0 mil GO bnds series February 2013 ser 2013 due 02/01/2038 Long Term Rating Illinois GO Long Term Rating Illinois GO VRDBs Long Term Rating Illinois GO (wrap of insured) (FGIC & AGM) (SEC MKT) Unenhanced Rating Illinois GO (wrap of insured) (MBIA) (AGM) (SEC MKT) Unenhanced Rating Illinois GO (ASSURED GTY) Unenhanced Rating Illinois GO (FGIC) Unenhanced Rating Illinois GO Unenhanced Rating
Many issues are enhanced by bond insurance.

A-/Negative

New

A-/Negative

Downgraded

A-/Negative

Downgraded

A-(SPUR)/Negative

Downgraded

A-(SPUR)/Negative

Downgraded

A-(SPUR)/Negative

Downgraded

A-(SPUR)/Negative

Downgraded

A-(SPUR)/Negative

Downgraded

Rationale
Standard & Poor's Ratings Services lowered its rating on Illinois' general obligation (GO) bonds to 'A-' from 'A'. At the same time, Standard & Poor's assigned its 'A-' rating to the state's $500 million GO bonds of February 2013. The outlook is negative. The downgrade reflects what we view as the state's weakened pension funded ratios and lack of action on reform measures intended to improve funding levels and diminish cost pressures associated with annual contributions. The aggregate pension funded ratios on an actuarial basis declined to 40.4% at fiscal year-end 2012, compared with 43.4% in fiscal 2011. Based on the state's current projections, the funded ratio will decline further to 39% in fiscal 2013. The continued decline in pension funded ratios is due in part to contributions below the annual required contribution, investment returns below assumptions, and lower investment return assumptions. While legislative action on pension reform could occur during the current legislative session and various bills have been filed, we believe that legislative consensus on reform will be difficult to achieve given the poor track record in the past two years. If there is meaningful legislative action on reform, we believe that there could be implementation risk based on the potential for legal challenges, and it could be several years before reform translates into improved funded ratios and budget relief. In addition, Illinois has to manage other challenges, which include pending statutory reduction of rates on the personal

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Summary: Illinois; General Obligation

and corporate income taxes beginning in fiscal 2015 and a high level of accumulated payables, combined with the more typical pressures facing the state sector in terms of a slow economic recovery, potential federal fiscal consolidation, and health care reform implementation. Key factors supporting the 'A-' ratings include what we view as Illinois': Deep and diverse economy, which is anchored by the Chicago metropolitan statistical area; Above-average income levels; Almost unlimited ability to raise tax and other revenues due to its sovereign powers and the absence of constitutional revenue-raising limits; Well-established priority of payment for debt service established by statute; 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 Recent efforts to improve structural budget balance and to enhance financial and budget management capabilities. Offsetting these generally positive credit factors are what we consider: Sizable budget-based deficits for fiscal years 2009 through 2012 despite revenue-enhancement measures implemented in 2011 that we view as significant; A historically large generally accepted accounting principles general fund balance deficit, which equaled $8.1 billion (about 22% of expenditures and transfers out) in fiscal 2011, with a $9.3 billion unassigned general fund balance deficit (25.3% of expenditures and transfers out). The fiscal 2012 audit has not been released; Large unfunded actuarial accrued liability (UAAL) for its five pensions, which stood at $95 billion (40.4% funded) at fiscal year-end 2012. This is in addition to a large $33.3 billion UAAL for Illinois' other postemployment benefits, which continue to expand; 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 broad and diverse, and the state's income levels are well above average. In our view, economic recovery continues at a modest pace. The state's unemployment rate declined through much of 2012 but remains above the U.S. The current rate is 8.7% through December 2012 according to the U.S. Bureau of Labor Statistics. Per capita personal income in 2011 was $43,721, or 105% of the U.S. average, ranking Illinois 14th nationally and first among the Great Lakes states. Although Illinois has experienced economic and revenue recovery and several revenue enhancements and overall spending restraint have improved structural budget performance in our view, revenues and expenditures have not been fully aligned and payables outstanding continue to be significant. The enacted budget for fiscal 2013 could improve structural alignment for fiscal 2013 and possibly lower the accumulated deficit and payables outstanding. The revenue forecast supporting fiscal 2013 spending is aligned with Illinois' current economic performance in our view and, based on a recent review of revenue performance, the state indicates that revenues are exceeding forecast by $776 million or 2.3%, but we acknowledge that some of this positive variance could be due to timing and taxpayer actions in advance of federal tax policy changes. There has been no formal adjustment to the revenue forecast at this time. Illinois projects a year-end surplus of $1.3 billion but that will likely be lower because appropriations for the state group health insurance program were only funded for six months.

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Summary: Illinois; General Obligation

We believe the budget has implementation risk in a range of areas, which could affect the year-end position. Although a reduction in payables would be positive in our view, significant accumulated payables remain and the reduction could be short-lived based on our analysis of the state's three-year financial plan where revenues will decline by about $2 billion and $4 billion in fiscal 2015 and 2016, respectively, based on the statutory reduction in personal and corporate income tax rates. The recent release of the three-year financial plan, which shows year-end balance through fiscal 2016, is based on sharp reductions in spending (5.7% and 13.6% across the board for most agencies) to offset this revenue decline, which would be very difficult to achieve in our opinion. This is especially true when viewed relative to the growing debt and liability burden. Illinois now projects a budget-based operating deficit of $477 million (1.4% of total expenditures and transfers out) for fiscal 2012. The total general fund balance deficit on a budgetary basis is forecast to be $5 billion (14.8% of expenditures and transfers). In addition, the state under appropriated spending for medical assistance in fiscal 2012, which is projected to increase Illinois' Section 25 liabilities to $3.8 billion for fiscal 2012 (from $1.8 billion in fiscal 2011). The state records Section 25 liabilities each year related to medical assistance and other health care expenditures. These liabilities represent spending for a fiscal year that was deferred or not funded in a given fiscal year and, by statute, can be paid from future appropriations. Standard & Poor's analysis of Illinois' total accumulated deficit includes the general fund deficit and Section 25 liabilities. The combined deficit now totals $8.8 billion ($5 billion general fund and $3.8 billion Section 25 liabilities) or 26% of general fund expenditures and transfers. Based on the analytic factors we evaluate for states, on a scale of '1.0' (strongest) to '4.0' (weakest), we have assigned a composite score of '2.5' to Illinois. (For more information, see full analysis published Aug. 30, 2012, on RatingsDirect on the Global Credit Portal.)

Outlook
The negative outlook reflects what we view as the range of challenges Illinois faces that will require legislative consensus and action. We believe the outcome of deliberations relating to pension reform and the expiration of current personal and corporate income tax rate increases on Jan. 1, 2015, along with other normal budget pressures, could have a profound effect on the state's budgetary performance and liquidity over the two-year outlook horizon. While it is unusual for a state rating to fall into the 'BBB' category, lack of action on pension reform and upcoming budget challenges could result in further credit deterioration, particularly if it translates into weaker liquidity. We could revise the outlook to stable if Illinois achieves pension reform that lowers liabilities and associated costs to the state and takes credible actions to achieve structural budget balance over the two-year outlook horizon. We believe there is limited upside potential for the rating in the next two years given the size of the accumulated deficit and the liability challenges Illinois faces but will evaluate the state's progress in addressing key budget and pension challenges. Temporary contact number: Robin Prunty (914-582-7470)

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Related Criteria And Research

U.S. State And Local Government Credit Conditions Forecast, Jan. 17, 2013 USPF Criteria: State Ratings Methodology, Jan. 3, 2011 USPF Criteria: Financial Management Assessment, June 27, 2006 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.

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