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Fitch Downgrades Cook County, IL's ULTGOs to 'A+'; Outlook Negative

NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded to 'A+' from 'AA-' the ratings for the following Cook County, Illinois (the county) bonds:

--Approximately $3.6 billion unlimited tax general obligation (ULTGO) bonds.

The Rating Outlook is Negative.

SECURITY

The ULTGO bonds carry the county's full faith and credit and ad valorem tax pledge, without limitation as to rate or amount.

KEY RATING DRIVERS

LACK OF PENSION PROGRESS: The downgrade reflects the challenges that the county faces as it attempts to shore up its severely underfunded pension plan. Meaningful improvement would require action by the state legislature, which is not expected to be back in session until the fall at the earliest, and possibly not until January 2015.

NOTABLE LONG-TERM OBLIGATIONS: The overall debt burden is moderate; however, unfunded pension liabilities are concerning and annual payments based on a statutory framework remain significantly lower than actuarial funding requirements.

REGIONAL ECONOMIC HUB: Cook County is the economic and cultural hub for the Midwest region.

CHALLENGING FINANCIAL PROSPECTS: Multi-year forecasts show improvement with a diminishing structural imbalance for the next several fiscal years. However, full funding of the actuarial required pension contribution likely would have produced weaker results in all years and is not included the forecast.

HEALTH SYSTEM PRESSURES: The county's health system has been a growing source of budgetary stress, with losses only partially offset by general government subsidies. While Fitch believes the system is poised for near-term fiscal improvement, longer-term concerns remain regarding the potential need for higher levels of county general fund support.

RATING SENSITIVITIES

MOUNTING LONG-TERM LIABILITY PRESSURE: The county has made some progress toward a solution for its underfunded pensions, but is dependent upon the state legislature to effect the changes. Inability to implement an affordable plan to shore up long-term pension funding would likely lead to a downgrade.

STRUCTURAL IMBALANCE: The rating will be downgraded if management fails to maintain structural financial equilibrium while incorporating adequate funding of long-term liabilities, and preserving fund balance levels that are satisfactory for the current rating level.

HEALTH CARE SYSTEM IMPROVEMENT: Fitch views the health system's ability to make an orderly transition to the new federal health care funding structure in a manner that does not increase the risk to general government financial operations to be important to stabilizing credit quality.

CREDIT PROFILE

Cook County, the second largest county in the nation, with 5.2 million residents, serves as the economic and cultural center for the Chicago metropolitan region. The city of Chicago, which is located within the county, accounts for roughly 50% of the county's total assessed valuation and population.

DIVERSE ECONOMIC BASE

Cook County, and in particular the city of Chicago, acts as the economic engine for the Midwest region. Residents are afforded abundant employment opportunities within this deep and diverse regional economy. The county also benefits from an extensive infrastructure network, including a vast rail system, which supports continued growth. The employment base is represented by all major sectors with concentrations in the wholesale trade, professional and business services and financial sectors.

Tax base drops of 4.3%, 10.8% and 10.5%, respectively, in 2011, 2012 and 2013, reflect lagging recessionary valuation declines, as property assessments are performed on a rolling three-year schedule. Socioeconomic indicators are mixed as is typical for an urbanized area, with above-average per capita income and educational levels but also elevated individual poverty rates. Unemployment rates have declined by over two percentage points over the past year as labor force contraction outpaced the modest growth in employment. As of May 2014, the county's unemployment rate of 7.6% remained above both the state (7.2%) and national (6.1%) averages.

PENSION & OPEB PRESSURES

Long-term liabilities related to post-retirement employment benefits are considerable and continue to threaten the current 'A+' rating. The county is reliant upon the state legislature to authorize adjustments to either the current benefit or funding structure.

The county's contribution for pension liabilities is capped by state statute and has not met the annual required contribution (ARC) for at least the last seven years. Compounding the issue is the pension fund's ability to allocate a portion of the statutory pension payment to other post-employment benefits (OPEB). The county's fiscal 2013 statutory payment allocated to pensions was approximately $155.5 million, or 26% of the actuarial ARC of $595.4 million. The portion allocated to OPEB in fiscal 2013 was $42.2 million, which equaled the pay-go amount. As a credit positive, the state created and the county implemented a two-tiered pension benefit plan for employees beginning in January 2011, which should help moderate future liability growth.

High investment returns in fiscal 2013 resulted in an improvement to the plan's funded ratio, but Fitch remains concerned since such returns cannot be relied upon to offset continued ARC underfunding. As of December 2013, the unfunded actuarial accrued liability (UAAL) totaled $5.3 billion and the funded ratio improved from 58.5% in 2012 to a still weak 61.5%, assuming a 7.5% investment return. Fitch estimates the funded ratio at a somewhat lower 58.3% using a slightly more conservative 7% investment return assumption.

A comprehensive pension reform plan which includes a sound, actuarially-based funding formula was introduced in the legislature in May. The legislation passed the state Senate but was not introduced in the House before the legislature adjourned. The legislation remains active, but the next opportunity for the House to act will be in January 2015, unless the legislature announces a fall 2014 session.

If passed, the reform would both lower the accrued liability through benefit changes and increase funding from both employee and employer. On the benefit side, COLA adjustments and limits, shifting retirement age and different calculation and capping of pensionable salary would significantly reduce the accrued liability. Contributions would also increase, with most employees paying a higher percentage of payroll and the county increasing its multiplier from 1.54x to 2.2x the employee contribution.

Beginning in 2020, the county's payment calculation would be subject to an 'actuarial backstop' minimum contribution equal to the amount necessary to produce 90% funding in 30 years, on a closed, layered loop basis. Actuarial projections show the multiplier-based calculation will require a higher payment than the actuarial backstop calculation in all years. If the legislation passes by the January session, the first large increase ($146 million) in the county's contribution is expected in 2016, bringing the employer contribution to $290 million.

Payments are projected to gradually increase until reaching a peak of $613 million, significantly higher than the $306.5 million the county is projected to contribute under the current statutory framework in the final, 30th year. The increased payments would be challenging for the county to incorporate into its already thinly balanced operating budget, but Fitch believes the county has the flexibility to manage them without materially diminishing its financial position.

Fitch believes the recent Illinois Supreme Court decision (Kanerva v Weems) stating that state employees' retiree health benefits are protected under the state constitution's pension protection clause will not impact the county's prospects for pension and OPEB reform, as the section of the Illinois statute governing the county's benefit structure explicitly states that retiree health care benefits shall not be construed to be protected under the pension protection clause.

MODERATE DEBT BURDEN

Cook County's reported aggregate debt burden is somewhat understated as the reported overlapping debt figure excludes suburban school districts, at a moderate at $4,026 per capita but elevated at 5.2% of market value. The county's debt profile includes a manageable 13% of unhedged variable-rate debt that is supported by liquidity facilities, the earliest of which expires in 2015.

Principal amortization is below average with 39.3% repaid within 10 years, but all debt is scheduled to be retired within 20 years. Future borrowing plans are moderate, including a possible commercial paper program in 2014. The 10-year capital improvement plan totals roughly $1.9 billion. New money GO borrowing is not anticipated prior to 2015.

RECENT FINANCIAL IMPROVEMENT BUT RISING FIXED COSTS

The county's home rule status affords it a wide variety of revenue options. Rollback of the sales tax rate and spending on wage increases, long-term liabilities and the county's health system continue to pressure financial operations.

The originally projected $267.5 million general fund budget gap for fiscal 2013 was largely eliminated through continued expenditure control. Unreserved general fund balance dropped from 14.6% of spending in fiscal 2012 to 10.8% in fiscal 2013, but remain well above the very low 2.3% of spending ($30.8 million) recorded in fiscal 2010.

The county has taken aggressive steps to control personnel costs through both attrition and layoffs; the county's budgeted personnel headcount has declined 9% or 2,400 positions since 2010, and filled positions are 1,500 less than that.

The county's finances would be under considerable additional pressure if full ARC funding was included. The county spent 7.1% of governmental funds spending on pensions in fiscal 2013, but full ARC funding would have required a much higher 27.3% of governmental spending. Carrying costs rise to a very high 39.6% when other long-term liabilities (debt service and OPEB pay-go) are added to the pension ARC.

BUDGET GAPS PRESENT A CHALLENGE

The county has made progress toward achieving structural balance; however, Fitch believes that structural balance will not be achieved until the county's spending plan includes annual, actuarially sound funding of long-term liabilities.

The adopted fiscal 2014 budget is balanced with measures to close the originally identified gap of $152 million (equivalent to 5.2% of spending). However, the statutory pension payment (some of which the pension fund may divert to OPEB), is well short of the ARC and will remain so, unless the state legislature amends the governing statute. Fiscal 2014 solutions are largely recurring although not yet realized. The county's ability to successfully address its budget gaps and institute structurally balanced operations is instrumental to rating stability.

HEALTH AND HOSPITAL SYSTEM STRAIN

The county's healthcare system, which is classified as an enterprise fund on a GAAP basis, has been a source of operating pressure due to a consistent history of operating deficits. Fitch believes the system is poised for improvement; however, the county's financial profile remains tangentially pressured until the system reaches solid operating footing.

The system generated a $394 million operating deficit in fiscal 2013, which was only partially offset by non-operating revenues, including a combination of property, sales, and cigarette taxes amounting to $246 million and a $21 million capital contribution from the county, resulting in an overall $67.6 million decline in the system's net position. Fitch believes further deficits and continued subsidization from discretionary revenue sources are likely, which may impact the county's overall financial flexibility.

The county is shifting focus to out-patient care, improving Medicaid billing collections, and increasing procedural efficiencies through infrastructure and technological upgrades, in an effort to improve cost efficiency. The health system also benefited from $171 million in disproportionate share hospital (DSH) funding in fiscal 2013. The county anticipates reduced levels of DSH funding through 2017; uncertainty around supplemental funding going forward is a credit concern but should be offset with the expected increase of insured individuals.

The system benefited from elevated revenues easing the transition to the Affordable Care Act (ACA). These additional revenues resulted from an 1115 federal waiver expanding Medicaid eligibility which brought in $117.5 million toward the system's current $1.1 billion budget. The waiver originally expired at the end of 2013, but the system received a six month extension which allowed it to accept new member applications through March of 2014. The ability of the system to increase revenues under the ACA and limit general fund exposure to the system will be critical to ratings stability.

Additional information is available at 'www.fitchratings.com'.

In addition to the sources of information identified in Fitch's Tax-Supported Rating Criteria, this action was additionally informed by information from Creditscope, University Financial Associates, S&P/Case-Shiller Home Price Index, IHS Global Insight, National Association of Realtors.

Applicable Criteria and Related Research:

--'Tax-Supported Rating Criteria' (Aug. 14, 2012);

--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 14, 2012).

Applicable Criteria and Related Research:

Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

U.S. Local Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=839161

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Contacts

Fitch Ratings, New York
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elizabeth.fogerty@fitchratings.com
or
Primary Analyst
Senior Director
Arlene Bohner, +1-212-908-0554
or
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
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Committee Chairperson
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