CHICAGO — Illinois' $1 billion general obligation sale Thursday is expected to benefit from improved investor sentiment following a pension system overhaul, though ratings agencies are keeping their powder dry.
After the pension legislation passed in December, the rating agencies said they were awaiting an actuarial assessment before incorporating their potential impact into the state's credit profile.
The state is the weakest rated among states at the low, single-A level with a negative outlook from two. Only Standard & Poor's shifted the state's outlook and that was a move to "developing" from negative.
The actuarial reviews are now in and show the original projections in the legislation were close to target. About $145 billion of savings are expected, down from an estimate of $160 million. The changes are expected to reduce Illinois' $100.5 billion of unfunded obligations and fully fund the system several years ahead of schedule.
But ahead of this week's deal, all three rating agencies have left the state's ratings and outlooks unchanged due to the legal challenge being mounted by retirees, employees, and unions.
They all also signaled that uncertainty over how the state will cope with the partial rollback of a temporary 2011 income tax hike on Jan 1, midway through fiscal 2015, is a central rating concern.
"If the reform survives legal challenge it would reduce unfunded liabilities and temper the growth in pension payments required by the state," Fitch Ratings said.
But Fitch stressed its concerns over the impact of the tax rollback saying "timely action" is needed.
"If pension reform moves forward and the state takes credible action to achieve structural budget balance beginning in fiscal 2015, we believe a higher rating would be warranted," Standard & Poor's said. "Conversely, if the pension reform is declared unconstitutional or invalid, or implementation is delayed and there is a lack of consensus and action among policymakers on the structural budget gaps and payables outstanding" a downgrade could occur.
Implementation of the reforms after a "favorable court ruling" could help win an upgrade from Moody's Investors Service. "Failure to address impending revenue loss from partial sunset of 2011 tax increases" or "significant further deterioration in pension funded status" could drive a downgrade.
The General Assembly's forecasting commission says a $1.6 billion drop in revenues lies ahead in fiscal 2015 and the governor's office has projected a $4 billion deficit in fiscal 2016 if revenue from the expiring tax is not replaced.
Citi is lead manager on the sale Thursday. State capital markets director John Sinsheimer and members of the finance team spent 10 days on the road to meet with investors and analysts to provide updates on the pension overhaul and budget projections, said deputy budget director Abdon Pallasch.
Sinsheimer said investors praised the reforms but recognize the state's ongoing challenges with a general view that the state's credit has stabilized, Pallasch said.
Investors have been generous in their assessment with spreads tightening by 50 basis points in trading of 10-year state paper, according to Municipal Market Data. That may not hold in the coming months as lawmakers ponder the fate of the income tax rollback.
Gov. Pat Quinn will show his hand in the fiscal 2015 budget but it's not expected to be released until after a March primary election.
"At this point, we see no reason to doubt that the tax surcharge will ultimately be extended, if only because there are few other revenue options available to the state," Triet Nguyen, managing partner at Axios Advisors LLC, said in a recent commentary. "However, in an election year, this process could still go down to the wire. Given Illinois paper's recent outperformance, investors may want to brace themselves for some more volatility going into the summer. In other words, hold on to your saddle as the ride could become a bit bumpier."
Quinn on Wednesday signed Senate Bill 1227 which formally allows him to push off the scheduled release of the fiscal 2015 budget from this month to March 26.
