CHICAGO – Borrowing to pay down Illinois’ $14 billion backlog of delinquent bills is the latest sticking point between Gov. Bruce Rauner and Democrats.
State Comptroller Susana Mendoza, a Democrat, attempted Monday to amplify pressure on the Republican administration to act on $6 billion of general obligation borrowing authorized in the $36.1 billion fiscal 2018 budget package.
The Democratic legislative majorities approved the budget in July and overrode Rauner’s vetoes with help from GOP members who broke with Rauner to end a two-year-old budget stalemate.
But the administration pushed back and said it’s not ready to move forward with the financing. The budget package requires the bonds to be sold by Dec. 31.
Mendoza turned to the public Monday, sparking a new round of sparring.
“You should know that this debt is costing you, the taxpayer, $2 million dollars a day, at up to 12% interest in late payment interest penalties…that’s brutal,” Mendoza said in a video address. Mendoza has estimated the interest cost of the current backlog at $800 million.
Mendoza voiced frustration with the administration for its lack of progress on the borrowing despite two letters urging action that were sent last month. Comptroller's office officials met with Rauner’s finance team from the Office of Management and Budget on July 14 but a timetable was not provided.
“It will take several weeks to put the bond deal together and the longer the wait, the more taxpayers will pay in higher interest rates,” Mendoza said. The backlog hit a record peak of $15.4 billion in June and now stands at $14.4 billion.
“Comptroller Mendoza is not telling the whole story,” said Rauner spokeswoman Laurel Patrick. The administration accuses Mendoza of not fully utilizing inter-fund borrowing included in the budget package and prioritizing Medicaid payments in order to leverage federal matching dollars.
“The governor’s final decision on bonding requires us to first know how much of the bill backlog can be addressed through means other than bonding,” Patrick said. “That is why we ask the comptroller to begin reducing the backlog of bills immediately.”
Asked later during a public event, Rauner suggested alternatives were under consideration and he wants to work with the General Assembly to enact an appropriation to pay down the debt.
“More borrowing in and of itself is not the answer…what we’ve got to do is have a plan to pay down out bills, pay down our debt, and have truly balanced budgets,” Rauner said.
Mendoza spokesman Abdon Pallasch said the office has acted on the interfund transfers permitted in the budget and it has leveraged federal dollars. “What we need right now is movement by the governor’s office and a solid timetable for refinancing the debt,” he said.
The budget package paves the way for the state to pay down the backlog by between $8 billion and $11 billion through the bonding, dipping into non-general fund accounts, and leveraging federal Medicaid dollars.
The approved plan, however, only supports $3 billion of $6 billion in authorized GO income tax proceed bonds by earmarking a $356 million end of the year surplus to cover the first year of debt service. Proceeds of a $3 billion issue – issued with a 12 year maturity and a structure that calls for level principal repayment -- could generate $2 billion in federal funds, bringing the backlog down by $5 billion.
The budget authorizes borrowing another $1.2 billion from other non-general fund accounts that must be repaid in two years and allows for a sweep of $1.8 billion from other non-general fund accounts that don’t have to be repaid. That brings the backlog down by $8 billion.
Under the budget package, the bonds are exempt from a 7% debt cap calculation but state GO rules apply that require at least 25% to be sold competitively.
Rauner previously supported a cash flow borrowing and the state’s finance team had been in discussions with lawmakers and investment bankers but that support was based on lawmakers reaching a compromise budget deal. Instead, Democrats forged ahead as the new fiscal year loomed July 1.
State Treasurer Michael Frerichs, who has also urged the administration to act on the cash flow borrowing, echoed Mendoza’s concerns this week. “Taxpayers paying $2 million in interest each and every day defies common sense and borders upon malpractice,” said Frerichs, who is a Democrat.
Frerichs noted that the backlog features prominently in the state’s credit profile and its eight downgrades since Rauner took office in 2015.
The borrowing would speed a reduction of the bill backlog as revenues from $5 billion in tax hikes will take time to flow into state coffers.
Passage of the budget eased mounting pressures on the state’s ratings that threatened to sink its ratings to junk territory. Last month, Fitch Ratings and S&P Global Ratings took their respective BBB and BBB-minus ratings off watch, with Fitch assigning a negative outlook and S&P a stable outlook.
Moody’s Investors Service concluded a downgrade review by leaving the state’s rating at Baa3 with a negative outlook. In putting the state’s rating on review, it cited as a factor the deep political divisions over the budget that raised implementation risks. The dispute over the borrowing represents an example of how budgeted measures could get hamstrung over the political acrimony.
Rating agencies and the buyside are keeping a close eye on the backlog and the state’s other persistent strains.
“While potentially helpful, it is unclear if consensus on the borrowing plan actually exists,” said a recent report from Nuveen Asset Management LLC that was authored by senior research analyst Molly Shellhorn on the state budget passage.
“Given the governor’s opposition to the budget, the path for implementation looks unclear. The bonds may not be issued, only a portion of the authorized amount may get issued or the timing may be delayed….still, the current plan should at least slow future backlog growth even if bond proceeds are not immediately available.”
The state may have escaped a cut to junk for now, but more progress in needed in structurally balancing the budget and reducing the backlog. “Avoiding a below investment grade rating should be a priority,” the Nuveen report said. “Longer term, growing pension costs still threaten Illinois’ ability to reach and sustain a structurally balanced budget.”
Investors should also expect no let-up in the political discord as the 2018 state elections approach.
“Headline risk and pricing volatility will continue to be risks of investing in Illinois credits and are unlikely to completely dissipate,” Nuveen wrote. “Adopting a budget was absolutely critical to stabilize the state’s credit quality, but Illinois still has work to do to improve its long-term credit trajectory.”
The state’s 10-year yield on Monday was at 3.93%, a 200 basis point spread to the Municipal Market Data’s top-rated benchmark, and its 20-year was at about 4.49%, a 195 bp spread, according MMD. The 10-year spread hit a high of 335 bp June 8 after an adverse court ruling and hovered in the 270s ahead of the budget showdown in late June and early July.
The Rauner administration could not immediately answer how much other borrowing might be undertaken during fiscal 2018. During the fiscal year, $2 billion of GOs and $2 billion of GO refunding bonds are excluded from the 7% debt cap and all GO and Build Illinois refunding bonds issued in fiscal 2018 are excluded from restrictions that require level principal payment, no extension of maturities, and that at least 25% to be sold competitively, according to an Illinois Commission on Government Forecasting and Accountability review of the budget.
Rauner’s recommended capital program projected the sale of $825 million of GOs and $200 million of sales tax-backed Build Illinois bonds.
School funding also remains up in the air. Rauner’s amendatory veto of an overhaul of funding formulas is expected to hold up the Aug. 10 payment to districts. The budget appropriation only allows for funds to be distributed under a new evidence based model such as the one in Senate Bill 1, which Rauner rewrote cutting the size of new aid to Chicago Public Schools.
Democrats refuse to accept the changes and a successful override is uncertain, leaving the aid distribution in limbo. The administration also had not yet released by Tuesday a detailed school-by-school analysis of the impact of his changes.
On Monday, Chicago Public Schools announced it was delaying release of its fiscal 2018 budget as it waits for the dispute to play out. It announced 950 layoffs but that’s an annual action based on enrollment.