With Illinois preparing to go to market with $500 million in general obligation bonds, the big three bond rating agencies, Moody’s, Fitch, and S&P have all issued their ratings of the new debt. Moody’s ranked the bonds as A2, Fitch at A and S&P at A- with all three agencies rating the outlook on the state as negative. This downgrade put Illinois’ bond rating as the lowest in the country. In comparison, the ratings on New Hampshire’s last bond issue were Aa1, AA+ and AA respectively, each 5 notches higher than their Illinois counterpart.
While seemingly archaic financial scores, bond ratings have a large impact on how much the state has to spend in interest payments over the life of the loan. Illinois State Treasurer Dan Rutherford has estimated that Illinois’ poor rating on the latest tranche of bonds will cost the state nearly $95 million.
Much has been made in the past few years over the dysfunction of Illinois’ finances and the legislature’s inability to get the state’s fiscal house in order; however, rating agencies are taking a closer look at another factor that weighs heavily on state finances: pensions.
All three of the rating reports of Illinois latest bond issue underscore the desperate need for pension reform.
The rating watch negative reflects the ongoing inability of the state to address its large and growing unfunded pension liability…Fitch believes that the burden of large unfunded pension liabilities and growing annual pension expenses is unsustainable. This large unfunded pension liability is despite the issuance of pension obligation bonds and passage of bipartisan comprehensive pension reform affecting new employees.
Moody’s also highlights the issue in their rating:
Illinois’ rating and negative outlook are consistent with our view that the state’s pension funding pressures are likely to persist and perhaps worsen in the near term. Lawmakers’ repeated inability to reach consensus on retiree benefit measures last year underscored the task’s extreme difficulty…Illinois is heading towards an unsustainable combination of higher pension contribution needs and reduced tax revenues.
S&P pointedly states that:
(t)he 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
So while this does not bode well for Illinois, what impact does this have on New Hampshire? No question, Illinois is in much worse financial shape than New Hampshire when it comes to both state finances and pension funding ratio. In New Hampshire’s last bond issue however, while all three agencies affirmed top ratings for the debt, they also highlighted the size of the pension unfunded liability as a concern going forward. (Fitch & Moody’s)
However, state pension systems that have higher funding ratios than New Hampshire, such as Pennsylvania, have seen debt downgraded in part due to pension liabilities. In Pennsylvania’s case, a combination of high debt and modest unfunded pension liabilities contributed to its downgrade. New Hampshire’s relatively light debt load so far has allowed the state to avoid costly downgrades despite a large unfunded pension liability.
To prevent New Hampshire from going down the path of Illinois or Pennsylvania, the state policy makers must keep bonding in check and not only hold the line on past pension reforms, but reform the system further by taking steps to spread the risk more equitably between the public employees and the taxpayers of the state.
[UPDATE: Illinois has postponed the bond issue mentioned below, citing “unfavorable market conditions”]