CHICAGO – While Illinois' falling bond ratings doesn't pose much default risk, investors should tread cautiously with the credit due to headline risks that could cut the value of their holdings, one buyside participant says.
"Our forecast is that spreads will continue to widen on state of Illinois debt as the ratings agencies continue to downgrade the state," Cumberland Advisors wrote in a commentary published Oct. 27. "As investors, while we view repayment in time and in full as close to a 'sure thing,' investors playing in the space expose themselves to loss due to headline risk."
The company doesn't buy either Chicago or state of Illinois debt whether it carries insurance or not and doesn't currently see value in the state's paper.
"The risks are asymmetric and impossible to predict," said the report's authors, John Mousseau, Michael Comes, and Robert Malvenda.
Fitch Ratings and Moody's Investors Service slapped the state with one-notch downgrades to the BBB-plus/Baa1 level in October over its fiscal strains and a political impasse over a fiscal 2016 budget. The state is straining to pay bills with its backlog up to nearly $7 billion. The downgrades followed the state comptroller's announcement that the November pension contribution, and possibly the December payment, would be delayed. State legislative leaders and Gov. Bruce Rauner are scheduled to meet in mid-November. The rookie GOP governor, who is at odds over the budget with the Democratic legislative majorities, recently said he doesn't expect a budget resolution then and has warned the stalemate could drag into next year.
Nuveen Asset Management in an October report also highlighted the lack of default risk even as the state grapples with a cash flow crisis.
"Despite the budget delays, we are not concerned about a payment default on either state's outstanding long-term debt," Nuveen wrote. "Illinois is one of the strongest states in terms of statutory protection for general obligation debt. Even without a budget, general obligation debt benefits from a continuous appropriation."
Illinois continues to collect revenues, but income tax is down since a temporary income tax hike partially expired Jan. 1, driving an expected loss of $4 billion in revenue this year. At the same time, the state continues to spend based on court orders and continuing appropriations at fiscal 2015 levels.
Cumberland noted that in 2014, Illinois's consolidated revenues from all non-business activities totaled $63.4 billion, dwarfing its debt service payments of $3.6 billion.
