CHICAGO – Investors should brace for further deterioration of Illinois’ already battered bond ratings after this week’s Fitch Ratings downgrade prompted state leaders to further dig their heels in over the state budget impasse, market participants said Tuesday.
Fitch dropped the state’s $26.8 billion of general obligation debt one notch down to BBB-plus Monday, an unusually low level for a sovereign state with wide ranging financial flexibility, as the ongoing four-month old budget stalemate chips away at its ability to tackle budget woes. The bleak prospects for a resolution were made clear as the state’s leaders issued statements attacking each other’s positions.
“I don’t know how much more patience the rating agencies will have. The state is going down a path that is going to be difficult to recover from,” said James Colby, senior municipal strategist at Van Eck Global.
“The rating agencies are sending a message that they are not afraid to downgrade into the BBB category,” he said.
“The longer this goes on the more likely it is there will be more downgrades,” said Matt Fabian, partner at Municipal Market Analytics. “It’s hard to see a way forward.”
Illinois saw it its ratings fall out of the double-A category to land at the A-minus/A3 level in mid-2013 during the previous administration of Gov. Pat Quinn over budget and pension strains but there they remained even though rating agencies warned of the potential for further hits.
The rating agencies have shown patience this year giving new Republican Gov. Bruce Rauner and General Assembly’s Democratic majorites time to resolve their political differences. Neither side has budged, leading to the fresh blow from Fitch. It shifted its outlook to stable from negative after the downgrade.
Fitch has rated only California at that level, in 2003 and 2009. Moody’s Investors Service and Standard & Poor’s still rate Illinois A3 and A-minus, respectively. It’s their lowest rated state. Moody’s assigns a negative outlook and Standard & Poor’s has the rating on watch with negative implications.
The downgrade is the first under Rauner’s watch and puts the state only three notches above speculative grade.
The state hasn’t issued debt since the spring of 2014.
“The state does expect to sell some bonds this fiscal year but is not ready now to announce amounts or sale dates,” said Rauner spokeswoman Catherine Kelly said Tuesday.
Trading on the state’s 10-year GOs has widened throughout the year by about 50 basis points to a spread of between 190 to 195 basis points to the Municipal Market Data’s top-rated benchmark.
Penalty levels have fluctuated in recent years depending on fiscal developments from the 2011 passage of a temporary income tax hike that partially expired Jan. 1 to passage of pension reforms that were voided by the Illinois Supreme Court in May.
Several market participants said the trading levels already reflect anticipated downgrades. Markit said it did not observe any immediate widening on Tuesday.
After Rauner took office early this year he proposed a $32 billion budget based on projected revenues.
Democrats rejected it and adopted a $36 billion plan of which Rauner vetoed most pieces.
Democrats want to erase an estimated $5 billion deficit through a mix of cuts and new revenues to make up the revenue being lost due to the lower income tax rates.
Rauner says he willing to consider tax hikes but not before lawmakers pass his governance and policy initiatives including a local property tax freeze accompanied with union negotiating curbs.
Democrats have balked and said such measures shouldn’t be tied to the state budget. Rauner counters that the two are linked and the reforms needed to get the state on sound financial footing by improving the business climate. There the two sides have sat for months.
The state’s fiscal strains can be tackled but the political divide prevents progress, analysts said.
“Illinois has the resources available to it,” Colby said.
By allowing political divisions to persist Fabian said the state “is doing everything in its power to deserve” negative credit action.
Fitch laid blame for the downgrade on the impasse, saying: “Once again, the state has displayed an unwillingness to address numerous fiscal challenges, which are now again increasing in magnitude as a result.”
The downgrade came just a few days after Comptroller Leslie Geissler Munger announced the state would push off its $560 million November pension payment until later in the fiscal year. She warned that the state has a $6.9 billion backlog and could close out the calendar year with an $8.5 billion bill backlog.
Rauner and the Democrats only dug their heels further in response to news of the downgrade.
“It’s time the legislature recognizes Illinois needs transformational change,” Rauner said in a statement.
State Senate President John Cullerton said “this lowered credit rating is just one way that we can calculate the true cost of doing business Rauner’s way.”
House Speaker Michael Madigan said: “Nowhere in Fitch’s statement does it suggest that the state needs to follow the governor’s agenda by weakening collective bargaining rights, reducing workers’ wages and hurting the middle class.”
The other rating agencies have issued their own warnings that cast questions over how long their patience will last.
Moody’s in a commentary Monday called the pension deferral over a cash flow crunch a negative credit factor.
In a July report, Standard & Poor’s said it would hold the state’s rating steady for the time being despite the gridlock but said its patience is limited. “We could take a rating action within the next two months, even in the absence of an adopted budget if, in our view, there is limited progress in budget deliberations or if credit fundamentals weaken,” its analysts wrote.