Illinois offering document paints a gloomier picture than its politicians

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CHICAGO – The Illinois budget labeled as “balanced” by Democrats and Republicans alike has an estimated $1.2 billion structural imbalance, according to the state’s new offering statement.

“To avoid future structural deficits, the governor and General Assembly would, among other potential solutions, need to reduce expenditures, adjust revenue collections, or approve a combination of revenue adjustments and reductions in expenditures,” says the preliminary official statement for a $920 million general obligation bond refunding set to price Wednesday.

Even as the state highlights its fiscal strides in a recorded investor presentation, the structural deficit is among "investment considerations" investors are warned about in the POS along with the state's bill backlog, weak ratings, and $129 billion of unfunded pension liabilities.

The state will shed the only floating-rate paper exposure in its $29.7 billion general obligation debt portfolio and cancel related interest rate swap contracts negatively valued at $74 million as of Aug. 1, according to the offering document. The state will current refund other debt for savings.

JPMorgan is running the books on the deal with Bank of America Merrill Lynch, Loop Capital Markets, Siebert Cisneros Shank & Co. and PNC Capital Markets as co-senior managers. Columbia Capital Management LLC is advisor and Swap Financial Group is swap advisor. Chapman and Cutler LLP and Burke, Burns & Pinelli Ltd.

“By converting the remaining outstanding variable rate bonds to fixed-rate bonds and terminating the swaps, the state will mitigate the interest rate risks associated with these instruments in a rising rate environment,” said administration spokeswoman Patty Schuh. “Additionally with the continued positive outlook from the ratings agencies, we are capitalizing on the tightening spreads of the state’s credit.”

This month's deal is expected to fare better in pricing than an April sale because Moody's Investors Service eased its outlook on its Baa3 rating of Illinois to stable from negative after the state passed its first on-time budget in several years. Ahead of the sale, the three major rating agencies affirmed their ratings: S&P Global Ratings has Illinois at BBB-minus with a stable outlook, and Fitch Ratings has Illinois at BBB with a negative outlook.

The budget relies on one-shot measures that lead to structural imbalance, such as $800 million of interfund borrowing and assuming $300 million from the long-stalled sale of the state government’s downtown Chicago headquarters.

Other fiscal risks that could leave the state with a cash hole this year include the reliance on $400 million in uncertain pension fund reform savings, largely from buyout programs that are not yet in place.

“While these buyout programs have yet to be implemented, it is expected to create savings for the state in the long term,” state budget director Hans Zigmund said in a recorded investor presentation. “The state can provide no assurance as to the amount of savings actually realized from the implementation of such programs.”

The state also has not accounted for $400 million in overdue raises based on experience that labor board rulings have said must be paid.

The General Assembly’s Democratic majorities and Gov. Bruce Rauner and most of his fellow Republican legislators struck the budget agreement ahead of an end of May deadline. It marked the state’s first, full-year, on-time budget agreement since Rauner took office in 2015.

All acknowledged the budget’s flaws but they still labeled it balanced, a description some rating agency analysts and investors disagreed with, particularly given the state's more than $6 billion of unpaid bills.

The lack of acrimony in crafting a budget as lawmakers focused on the November elections marked a sharp contrast to a year earlier when Rauner vetoed a fiscal 2018 budget that raised income taxes. Some GOP members broke ranks to override the veto.

Rauner is again ramping up his attacks on the tax hike, even though he signed the new budget that relies on more than $4.5 billion in additional revenue generated by the income tax increase.

He labels it the Madigan tax hikes, referencing House Speaker Michael Madigan, and warns of the close ties between Madigan and the Democratic candidate in the governor's race, J.B. Pritzker. Rauner accuses both of planning further raise taxes. Pritzker supports moving toward a graduated income tax from the current flat tax, which would require changing the state constitution.

At the same time, Rauner's finance team paints a rosier picture supported by the revenue from the tax hike.

“Several developments which have taken place since the beginning of fiscal year 2018 are putting the state on an improved trajectory for the future,” state capital markets director Kelly Hutchinson says in a recorded investor presentation, saying the permanent income tax hike “helped drive a 21% increase in general fund revenues.”

Hutchinson also highlights passage of the fiscal 2018 and 2019 budget and the bill backlog reduction to $6.8 billion at the close of fiscal 2018 on June 30. That’s $900 million better than expected. Other positives include the plan to shed the state’s only floating rate risk and swaps that will lower interest costs and risks and the U.S. Supreme Court’s decision paving the way for states to collect sales taxes from online companies, Hutchinson said. Another plus is the anticipated $1 billion reduction in debt service in fiscal 2020 as portion of the state’s pension related debt is retired.

Zigmund touted the state’s improving economy, growing per capita income, and declining unemployment.

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