Election stakes are high for Illinois budget negotiations, writes Loop strategist Chris Mier.

CHICAGO – Illinois heads back into the market Thursday with investors and analysts looking ahead to the Nov. 8 election because the outcome of legislative races could influence the state's longstanding budget gridlock.

Illinois takes competitive bids Thursday on $480 million of 25-year general obligation bonds. The sale follows a $1.3 billion GO refunding in mid-October led by Bank of America Merrill Lynch and Jefferies.

The state – hit with a fresh downgrade, a crowded supply calendar, and yield fluctuations – saw its spreads widen from its previous sale and from recent secondary trading levels.

The 10-year maturity landed at 193 basis points more than the top-rated Municipal Market benchmark compared to 185 basis points on a June Illinois pricing and 155 basis points on a January sale. Trading over the summer had narrowed to between 160 and 175 basis points.

Several sources said BAML took between $100 million and $150 million of the $1.3 billion into its own inventory. The state reported savings of $15 million in fiscal 2017 from the refunding and $60 million over the life of the bonds.

Market participants are looking ahead to next week's election and its potential to shake up Illinois' political dynamics.

"Though Illinois' electoral votes are certain to go to Clinton, elections for state legislature have the potential to impact the political balance in the state, which has not had a full budget in over a year," Loop Capital Markets' municipal strategists Chris Mier and Bridgett Stone wrote in a report last week.

"There are a few reasons to hope the budget stalemate will end after the November elections. The vote threshold to pass legislation will be lower post-election, and a lame duck session in January could make difficult votes easier for outgoing legislators," Nuveen Investments wrote in a recent market commentary. "Lawmakers should be more willing to pass a budget once the hurdle of reelection is behind them, regardless of which party is able to claim greater popular support following the election."

It was during a lame-duck session in 2011 that lawmakers approved a temporary income tax hike. The partial rollback of those rate increases at the beginning of 2015 has driven the state's $5 billion budget deficit and nearly $10 billion backlog of unpaid bills because the state lost $4 billion of annual tax revenue.

Unable to bridge their political differences for the second straight fiscal year, the first-term Republican governor and Democrat-controlled General Assembly struck a stopgap budget agreement in late June.

"The bridge was viewed as a success …. we hope that has created trust …. and serves as a good foundation on which to move forward after the election," Gov. Bruce Rauner's Office of Management and Budget director Tim Nuding said in an investor presentation about the upcoming bond sale. "The governor does support working together with the legislature for a comprehensive package and a balanced budget that includes economic reforms, revenue, and spending reductions."

Rauner won't support a tax hike unless Democrats back off their opposition to his legislative agenda that includes local government work rule changes, tort and worker's compensation reforms and term limits.

Whether state leaders can finally bridge their differences in a post-election atmosphere remains to be seen but market participants agree that the outcome of legislative races will play a role.

While current lawmakers who will participate in the lame-duck session, the election results will loom large because they stand to influence each side's bargaining power.

Democrats now enjoy what should be a veto-proof three-fifths majority in both chambers, but the House margin is narrow at the minimum threshold of 71 and some Democrats can't be counted on to follow in lockstep with longtime House Speaker Michael Madigan, D-Chicago.

The House breakdown is 71 Democrats and 47 Republicans while in the Senate Democrats hold 39 seats and Republicans 20. All House seats are up for election as are two-thirds of Senate seats.

"Should the Democrats secure a true supermajority in the House this fall, they may act emboldened with new political leverage," Nuveen wrote. "However, we believe support from both parties will ultimately be needed to reach any budget agreement that requires a tax increase."

Illinois voters have been inundated with legislative race campaign advertisements that highlight the candidate's connections to either Rauner and Madigan and each side lays blame for the state's fiscal woes at those leaders' feet.

"This year's elections have largely been seen as a proxy battle between House Speaker and Illinois Democratic Party head Michael Madigan and Gov. Bruce Rauner," Loop wrote.

Rauner's Republicans could retain or even pick up seats where he ran strong in 2014 but Loop suggests another potential outcome favoring Democratic candidates.

"Recent polls have Clinton winning over 55% of votes in the state," Loop wrote. "If Clinton draws out Democrats in larger numbers, this could have an impact of down-ballot races, particularly as voters are unlikely to split the ballot between two parties." Clinton is a native of the Chicago suburb Park Ridge.

Republicans had spent $32.7 million on races between July and September, with heavy funding coming from Rauner, while Democrats have spent about $7.4 million, according to an Associated Press story that cited Illinois Campaign for Political Reform figures.

Illinois is the lowest rated state and faces further rating erosion if it doesn't resolve its budget and pension strains.

S&P Global Ratings downgraded Illinois ahead of the refunding sale to BBB, leaving its outlook at negative.

Fitch Ratings affirmed its BBB-plus rating and left the credit on negative watch. Fitch will resolve the placement in January after lawmakers return for the lame-duck session. Moody's Investors Service rates the state Baa2 with a negative outlook.

Lawmakers are also expected to tackle pension reforms. The state's $113 billion of unfunded liabilities have contributed heavily to its credit slide and concerns about growing pension costs due to actuarial assumption changes at several of the state funds have driven recent headlines.

The fate of about $200 million in teachers' pension funding help from the state for Chicago schools hangs in the balance because lawmakers approval was conditioned on the adoption of state pension reforms.

The election also will decide the fate of the state comptroller's office in a special election. The comptroller oversees state bill payment and serves as a repository for state and local government financial information. Incumbent comptroller Leslie Geissler Munger, a Republican appointed to the post by Rauner, is being challenged by Chicago's city clerk, Susana Mendoza, a Democrat.


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