The passage of Illinois’s budget, which is scheduled for tomorrow despite the veto of Gov. Rauner which was duly overridden on July 4, was supposed to be the critical catalyst that saved the state from a downgrade to junk status by the rating agencies, a first in US history. Unfortunately, moments ago Moody’s said that the passage of the budget may have been too little too late, and moments ago the rating agency said that it had place the rating of Illinois’s Baa3 general obligation under review for possible downgrade, citing the state’s failure to fully enact timely budget for fiscal year that began July, and its failure to achieve broad political consensus on how to move toward balanced financial operations.
A downgrade from Baa3, even by just one notch, means that Illinois would become the first US state rated junk, potentially forcing many muni bond managers to dump its bonds, and sending its costs of funding sharply higher despite a relief rally that took place today on hopes the state’s day of reckoning had been pushed indefinitely into the future.
In short: the scramble to pass a budget may have been for nothing.
The full note from Moody’s is below:
Moody’s Investors Service has placed the general obligation rating of the State of Illinois, currently Baa3, under review for possible downgrade following the state’s failure to fully enact a timely budget for the fiscal year that began July 1, and its failure to achieve broad political consensus on how to move toward balanced financial operations.
The review also applies to several related state debt ratings: the Baa3 assigned to sales-tax backed Build Illinois bonds and the Ba1 ratings assigned to Illinois subject-to-appropriation bonds, the convention center bonds issued by the Metropolitan Pier and Exposition Authority and bonds issued under the state’s Civic Center program. Illinois has outstanding debt of about $32 billion, of which 82% is general obligation.
The state’s government in recent days has made legislative progress towards a fiscal recovery plan based on permanent income tax rate increases, after going through two fiscal years without a complete budget in place. The decision to place the state’s ratings under review for downgrade incorporates our expectation that the legislature will implement revenue increases, overriding the governor’s vetoes. The review will provide a limited amount of time for the Illinois General Assembly to finish voting on the measures, and for assessment of the plan’s credit implications. The review process will also address the likelihood of further deterioration in Illinois’ most pressing credit challenges: its severely underfunded pensions and a backlog of unpaid bills, which has doubled during the past year.
Despite the progress toward budget balance that the emerging fiscal plan embodies, the plan entails substantial implementation risk. The governor yesterday vetoed the plan’s revenue, spending and implementation legislation, citing a $2 billion current-year deficit and the plan’s failure to incorporate proposals in areas such as workers compensation insurance reform and caps on local property taxes. The plan’s approval relied almost entirely on Democratic party support in the state’s senate, and a vote to override the governor’s vetoes of the measures has been deferred by the state’s house of representatives. The plan therefore appears to lack broad bipartisan support, which may signal shortcomings in its effectiveness once implemented. In addition, the state’s baseline tax collections declined in fiscal 2017, suggesting that any tax increase may yield less revenue than anticipated in coming months.
So far, the plan appears to lack concrete measures that will materially improve Illinois’ long-term capacity to address its unfunded pension liabilities. A June 30 order from a federal judge that the state accelerate payments owed to Medicaid managed care organizations and service providers cast doubt on the state’s immediate ability to keep up with its statutory pension contribution schedule while also meeting obligations for debt service, payroll and school funding.
The state anticipates addressing its approximately $15 billion backlog of payments owed partly through a bond offering that probably will rank among the largest in the state’s history. This component of the state’s broader fiscal plan leaves Illinois not only dependent on market access to ease liquidity pressures, but also facing a significant increase in its tax-supported debt burden. Moreover, the effectiveness of the state’s strategy to contain and reduce its deferred bills, once the backlog-financing debt has been issued, remains to be seen.
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