Illinois may dig deeper credit rating hole

A move being considered by the state of Illinois to sell up to $4.1 billion in pension obligation bonds at best could help maintain one of the worst state credit ratings in the nation and at worst lead to further downgrades for the cash-strapped state, according to ratings agencies.

The revenue generated from the proposed sale would go to three statewide pension plans. About $2.358 billion would go to the $33.2 billion Teachers' Retirement System of the State of Illinois, Springfield; $960 million to the Illinois State Board of Investment, Chicago; and $777 million to the $12.9 billion Illinois State Universities Retirement System, Champaign.

Illinois already has about $13 billion in pension obligation bonds still outstanding from $10 billion sold in 2003 and $3.4 billion in January.

Illinois is on credit watch from ratings agency Standard & Poor's, New York, with a rating of A+; it has been on watch since 2008 because of budget shortfalls and legal challenges against then-Gov. Rod Blagojevich, Robin Prunty, a director in S&P's public finance ratings group, said in a telephone interview. S&P put Illinois on credit watch with negative implications on March 23.

“All along it's been about their budgetary performance,” Ms. Prunty said, noting that California at A- is the only state with a lower credit rating.

Late last week, the General Assembly was hashing out a deal that would increase the state income-tax rate to 5.25%from 3%, which likely would help bolster the state's credit rating.

A Standard & Poor's report issued on June 15 states that an unwillingness to make structural changes to the state budget could result in a lowered rating. It also notes that issuance of more pension obligation bonds “place a strain on future budgets, especially when viewed in the context of increasing pension contributions that result from a low funded ratio.”

Another ratings service, Moody's Investor Services, thinks the bond sale won't change the funding woes of the state plans anytime soon. In a report issued Dec. 6, said the combined funded level of Illinois' state retirement systems would weaken further regardless of the additional pension bond sale.

The issuance “would at least limit deterioration in the funded status of the state's pensions, which are the lowest-funded among states,” the one-page report said. “Nonetheless, we expect the state's pension funded ratios to weaken further before improving, given that statutory contributions are below the actuarially determined amounts needed to amortize the plans' unfunded liabilities.”

The Illinois State Employees' Retirement System, which makes up about 95% of ISBI's DB assets is roughly 35% funded, while TRS is about 48.4% funded and SURS was 54% funded as of June 30, 2009, the most recent data available.

Ted Hampton, New York-based assistant vice president and analyst at Moody's, said in a telephone interview that issuing bonds to pay pension bills typically would have a negative impact on a state's credit rating, but it could have a neutral effect on Illinois.

“Deficit financing is not favorable, but in this highly unusual situation with a low-rated state continuing to struggle financially, we view the execution or completion of this financing as an important goal because the state needs to contribute to its pensions, which are severely underfunded,” he said.

The pension bond sale now under consideration was passed by the state House of Representatives May 25 but has languished in the Senate since then. The Illinois Senate is currently in a lame-duck session, and Senate President John Cullerton, the bill's sponsor, said he expects a vote on the proposal before the session ends Jan. 11.

Meanwhile, officials at the state plans are considering what to do with the money after going without a contribution from the state in the current fiscal year.

Illinois State Board Executive Director William R. Atwood said in an interview earlier this month that a large part of the proceeds from the bond sale would be used to buy back bonds and stocks that the system has sold since July 1 to pay pension benefits left unfunded by the state.

Mr. Atwood said proceeds from the sale would go to RhumbLine Advisers, which manages four index funds for the system—a $630 million S&P 500, a $520 million Russell 1000 value, a $368 million Russell 1000 growth and a $77 million Russell 2000 value portfolio—and State Street Global Advisors, which manages a $513 million MSCI All-Country World, ex-U.S., index fund for the system.

The system would later redeploy the funds to active management, but Mr. Atwood noted that LSV Asset Management, which runs $463 million in active large-cap value domestic equities for the fund, and Chicago Equity Partners, which manages $900 million in active intermediate government and credit fixed income for ISBI, could receive some of the funds immediately, depending on their ability to immediately invest the funds.

If approved, Mr. Atwood said ISBI expects it would receive the funds sometime in March.

ISBI oversees the investments of the Illinois State Employees' Retirement System, the Illinois Judges' Retirement System and the Illinois General Assembly Retirement System.

The picture is less clear about how funds would be deployed at the Illinois teachers' and universities systems.

“We're not counting our chickens until they're hatched,” David Urbanek, a spokesman for the teachers' retirement system, said in a telephone interview.

Daniel L. Allen, chief investment officer of the Illinois universities system, could not be reached for comment.

Asked about his concern about whether additional borrowing would further damage the state's bond rating, Senate President Cullerton's spokesman John Patterson said in an e-mailed response: “The larger package the Senate president is working on would allow the state to pay its bills on time and re-establish a sound fiscal footing. That would send a strong, positive message to current and prospective creditors.”