Rating agency says Illinois has more budget work to do

By Jamey Dunn

 One bond rating agency says that if Illinois does not do more to balance its budget before the recent tax increase begins to phase out, the state could face another hit to its credit score.

Fitch Ratings held Illinois’ rating steady at “A” with a stable outlook. (You must log in to see the report.) However, the rating means Illinois continues to be the second lowest rated state in the nation, behind California. The rating came as Illinois looks to sell bonds for capital construction projects. The state’s bond rating are used to determine the interest rates it must pay on debt.

An analysis from Fitch says Illinois has taken some steps in the right direction to close the budget gap, such as the recent income tax increase. However, the analysis notes that the state will still end the current budget year with a deficit of more than $500 million. The rating agency says that Illinois has more work to do to address long-term problems. “While the actions taken were positive, significant challenges remain. The tax increases are temporary and will begin to phase out in 2015. Even if the state has achieved budget balance by that point, it will once again be faced with a significant budget balancing decision to make severe expense reductions that it has been unwilling to make up to this point, identify new revenues or make permanent the tax increases. In addition, there is limited ability within the existing budgetary framework to reduce the accounts payable backlog in a meaningful way without reliance on debt issuance, which has yet to be authorized,” the report said.

Fitch analysts agree with Quinn that the projected pension payment of $5.2 billion, which is a 27 percent increase over the FY 2012 payment, and increased Medicaid costs, including bills that were pushed to next fiscal year, will put pressure on the FY 2013 budget. Quinn wants to keep education and health care spending flat next fiscal year, which his budget office says will require an approximate 9 percent cut to all other areas of state government.

Even with cuts next fiscal year and generally flat spending levels in the next two fiscal years, Quinn’s budget office projects a more than $800 million deficit in FY2015, which is when the recent income tax increase begins to phase out. Fitch’s report says that if Quinn and lawmakers wait too long to address the issue of the tax increase phase out, the state’s credit rating could be downgraded. “Deterioration in the state's financial position, as evidenced by excessive use of non-recurring revenues or additional payment deferrals in the budget, could lead to negative rating action. Also, pushing up against the expiration of temporary tax increases in fiscal 2015 without a solution in place would put extreme pressure on the budget and likely lead to a [negative] rating action,” the report said.

“We hear and acknowledge from rating agencies and investors that additional bipartisan action to implement further cost reductions and reforms is needed in this upcoming legislative session to achieve fiscal stability in our state,” said Kelly Kraft, Quinn’s budget spokesperson. Kraft said that Quinn is considering potential Medicaid and pension changes that would create savings and also hoping for increased revenues from economic growth to help stabilize the budget before FY 2015.

Karen Krop, the primary analyst on Fitch’s report, said that Illinois must take steps to address the issue by the FY 2014 budget year at the latest. “When you get into 2014 budget, one would hope that they would be talking about how they are going to deal with that in the coming year.” But Krop noted that Illinois officials have a history of “waiting until the last minute” to address difficult situations. “If the income tax had been raised sooner, we wouldn’t have this accounts payable problem,” she said.

The rating agency has yet to embrace Quinn’s plan to borrow money to pay off the backlog of unpaid bills. According to Fitch’s report, the state was able to pay off $1 billion in late bills with revenues from the tax increase, which brought the total down to $5.2 billion. But the report says the state expects an increase the amount of unpaid bills in the remaining months of the current fiscal year.

Krop said that Illinois is unlikely to see its bond rating improve until it addressed the backlog. The report calls for “a comprehensive approach to reducing the accounts payable backlog that does not significantly exacerbate the state's already high debt position.” Krop said that doesn’t rule out borrowing, but that Illinois should make cuts and other budgeting efforts and borrow as little as it can to make up the difference. She noted that paying off the bills would create an economic boost for Illinois. At 6.2 percent of 2010 personal income, Fitch classifies the state’s debt level as “moderate but above average.” Krop said Quinn’s previous proposal to borrow $8 billion, to pay late bills and other costs, would have pushed that level into the “high” range. “It’s clearly a problem that needs to be solved. There’s been this overhang accumulating for a few years,” she said. “The question of how to resolve it is kind of up to the state.”