CHICAGO - Illinois began to feel the financial fallout of Gov. Rod Blagojevich's corruption scandal after Standard & Poor's cited it in its decision to put the state's credit on negative CreditWatch and finance officials delayed a $1.4 billion cash-flow issue yesterday as they awaited final approval of the transaction documents from some state officials.

"The CreditWatch placement reflects our opinion of the state's growing budgetary shortfall, now projected at $2 billion for the current fiscal year, and our concern that the legal charges now facing the governor and his chief of staff may challenge the state to respond to this fiscal situation on a timely basis," Standard & Poor's analyst John Kenward wrote in a report issued late Wednesday on the state's AA credit.

The fiscal issues provides further fuel for local, state, and national figures who are pressuring Blagojevich to resign following his arrest, along with his chief of staff John Harris, by federal agents Tuesday on charges they conspired to commit mail and wire fraud and solicitation of bribery.

The criminal complaint against the two alleges a series of pay-to-play and shakedown schemes to benefit the governor and eliminate critics on the Chicago Tribune's editorial board. The most stunning allegations were that the governor sought to sell to the highest bidder his right to replace President-elect Barack Obama in the Senate.

The Illinois General Assembly will convene Monday to strip the governor of his power to replace Obama by scheduling a special election. If the governor does not resign soon and lawmakers don't act to impeach him, Illinois Attorney General Lisa Madigan is prepared to ask the Illinois Supreme Court to remove the governor. Standard & Poor's yesterday updated its report - issued in conjunction with the agency's review of the $1.4 billion general obligation certificates sale - after it learned the state had postponed the sale to Tuesday, Dec. 16 from its scheduled issue date yesterday.

The delay means that state vendors - including health care and social service providers - will have to continue their wait for payments. State Comptroller Dan Hynes has reported a record backlog of $4 billion in unpaid bills. Questions also remain over whether the sale will occur as now planned because Madigan's office said it is still reviewing legal issues involving its certification of certain documents.

"The comptroller has said that the governor needs to be removed from office, and everything is in jeopardy while we continue to be in a state of flux," Hynes spokesman Alan Henry said yesterday.

The Office of Management and Budget issued the preliminary offering statement for the sale late last week with the initial approval of Hynes and state Treasurer Alexi Giannoulias. Madigan must sign off on the final documentation.

The federal charges announced Tuesday threw a wrench in the process. Budget director Ginger Ostro released an addendum to the OS alerting investors to the governor's arrest and seeking to assure potential bidders that the looming charges posed no threat to the state's ability to repay the notes.

"None of the allegations have any relationship to or impact on the state of Illinois' cash position, the need for short-term financing, or the ability of the state to repay the short-term financings," she wrote.

Late Wednesday, finance officials decided to postpone the sale over concerns that the distraction of the corruption scandal might stall final approval on the closing documents which was being sought ahead of the pricing to ensure that the state would deliver on the securities.

"The charges have proven to be a distraction," said one source familiar with the deal.

One source said it was unusual to seek such approval of the closing documents before the pricing, but another said it was needed up front to ensure the state would deliver on the notes.

The comptroller's and treasurer's offices did not comment on the status of their approval. Madigan spokeswoman Natalie Bauer said the office had not received the final documents because the sale date was delayed.

In light of the federal case now leveled against Blagojevich, the office is "reviewing whether or not we can do those certifications due to the governor's arrest and criminal charges," she added. "That's because of language citing pending or threatened litigation or any controversy that questions the governor's ability to hold his office."

Under current law, the state must limit issuance in anticipation of revenues to no more than 5% of the state's appropriations for the fiscal year, and the notes must be repaid from revenues received during the same fiscal year. The state's fiscal year ends June 30.

A spokeswoman for the governor issued a statement saying only: "We continue to believe it is important to pay community organizations that provide services to Illinoisans, but at this time, it is prudent to extend the process."

The notes mature in three tranches in 2009: $400 million due April 24, $600 million due May 25, and the remaining $400 million due June 24, according to the offering statement. Market participants on short-term desks said there appeared to be solid demand for the notes, but any delay could hurt as investors move to close their books on the year. Ice Miller LLP is bond counsel.

Fitch Ratings rates the state's $25.5 billion of GOs AA with a negative outlook. Analyst there said they were not asked to rate the transaction. Moody's Investors Service rates the state Aa3 but an analyst there said he could not comment on whether the agency had been asked to provide a rating.

Given the state's fiscal stress, Standard & Poor's said it's worried the corruption scandal will hurt the state's ability to resolve its financial problems, including a $2 billion budget deficit.

"We understand that a number of state officials and legislators have called for the governor's resignation or impeachment, which we believe does not bode well for future cooperation between the governor's office and the legislature," Kenward wrote.

The AA rating is supported by a deep and diverse economy anchored by the city of Chicago and its suburbs; income levels that are above the nation's averages; and the state's ability with legislative approval to tap cash surpluses for operations in non-general fund accounts, Standard & Poor's wrote.

But the agency views negatively the state's growing negative balance based on generally accepted accounting principles; its massive unfunded pension liabilities of $54.38 billion, and a $24.2 billion other post-employment benefits unfunded liability; and a high debt burden.

General fund revenues for the current fiscal year that runs to June 30 were revised last month downward by $1 billion from previous estimates due primarily to an anticipated $800 million drop in income and sales taxes. The state expects to receive $336 million less in federal Medicaid reimbursements and has $655 million of unfunded spending in the current budget.

The governor returned to work Wednesday and continued yesterday to ignore the mounting pressure to quit. The U.S. Senate has also weighed in, with all members signing a letter insisting that the governor resign and warning him that they would not seat any appointment of his to fill Obama's spot.

The Illinois House is expected to discuss next week initiating the impeachment process if Blagojevich does not resign, but it's unclear how they may proceed.

Madigan "is prepared to take action" in a "reasonable" amount of time if lawmakers do not act. Under a little-known Illinois Supreme Court rule, she said she can go before the state high court and ask its seven justices to declare the governor unfit to govern, a spokeswoman said.

Lieut. Gov. Pat Quinn, who would take over if the governor resigns or is removed from office, said yesterday he might consider naming a Senate replacement to ensure that the seat is filled quickly.

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