CHICAGO -- With its $6 billion backlog borrowing in the rear-view mirror and chatter over a possible cut to junk quieted down, Illinois will return the market with fresh rating agency warnings over the need to correct a fiscal 2018 budget gap and hold its bill backlog in check.
“A budget gap has already emerged due to changes in assumptions for both revenues and spending,” Fitch Ratings said in its report ahead of the sale next week. “The rating will be downgraded if the state returns to a pattern of deferring payments for near-term budget balancing and materially increases the accounts payable balance.”
A projected $1.5 billion gap is due in part to weaker-than-forecast fiscal 2017 revenues, delays in implementing creation of a third-tier pension plan, and interest costs on a portion of the $6 billion of borrowing not accounted for in the $36 billion fiscal 2018 budget. Gov. Bruce Rauner’s administration last month estimated a $1.7 billion hole but he trimmed it by $200 million through cuts.
The state will take competitive bids Nov. 29 on $750 million of general obligation bonds that are divided into two series. One for $655 million matures in 2042 and the other for $95 million matures in 2027. The first series will finance projects in the state’s capital program and the second, shorter-maturing series is financing information technology projects.
Sycamore Advisors LLC is advising the state. Chapman and Cutler LLP and Hardwick Law Firm LLC are co-bond counsel.
Illinois heads into 2018 with its ratings barely in investment grade territory as attention returns to the budget process.
In recent days Fitch Ratings affirmed its BBB rating on Illinois GOs, and S&P Global Ratings affirmed the rating at the lowest investment grade rating of BBB-minus. Fitch assigns a negative outlook and S&P a stable one.
Moody’s Investors assigned its Baa3 rating and negative outlook in an October report about the $6 billion in GO borrowing to pay down a record $15 billion backlog as well as the $750 million of new money. The state has nearly $31 billion of GO debt.
The state needs to fix the more than $1 billion projected gap and also craft a spending plan for the fiscal year beginning July 1.
Deep divisions over spending, tax, and policy issues between the first-term Republican governor and the Democratic-controlled General Assembly drove an impasse that left the state government without a budget for two years and dragged the state’s ratings down.
Though the state has a budget this year after Rauner's veto was overridden, the positions behind the impasse have not changed and with a 2018 election looming it’s unclear whether the two sides can reach accord on any fiscal matters.
"The governor has to focus on a budget blueprint for coming fiscal year, but we are certainly interested in working with the General Assembly to solve the deficit for the current fiscal year. Similar to FY 15 when Governor Rauner came into office, we’ve now inherited a deficit budget," Rauner spokeswoman Patty Schuh said of the budget process.
The 2018 budget was adopted only after some GOP members broke with Rauner. And Rauner in a tweet Tuesday contradicted his finance team, which has sought in investor presentations to underscore the state’s improved fiscal condition with a budget in place.
“Illinois is at the edge of disaster, that is why this election is so important. I am committed to getting corrupt leadership out of the Legislature and protecting Illinoisans from bad government,” said the tweet from Rauner’s personal campaign account.
“Although the state now operates with an enacted spending plan, there is little to suggest that the cloud of dysfunction has lifted from state budget politics,” S&P analyst Gabriel Petek wrote in the agency's report on the new bond sale. “As it relates to Illinois' finances, we view the state's political climate as tainting its ability to execute prudent fiscal policy. Not least, it materially impedes any prospects for resolving the structural deficit that remains following budget adoption.”
“In our view, this underlying fiscal imbalance represents a vulnerability that could fuel additional long-term fiscal deterioration,” Petek said in the report.
All three ratings agencies are watching closely for whether the bill backlog again will swell which would raise a red flag given the additional burden dumped on to the state’s GO debt load to bring down the backlog.
“Structural imbalance that leads to renewed build-up of unpaid bills following issuance of debt to pay down backlog” could drive a downgrade, Moody’s warned.
“If the bonding plan is not paired with additional fiscal adjustments, the state could be left with a higher tax-supported debt burden and--once again--an escalating backlog of unpaid bills,” S&P said.
The state closed Nov. 8 on its $6 billion of GO borrowing to pay down the backlog, which ballooned over the two years without a state budget as spending continued unabated on many fronts under continuing appropriations, court orders, and legal agreements, and stopgap spending bills.
State Comptroller Susana Mendoza deposited $2.5 billion to the general revenue fund to pay off Medicaid vouchers with another $4 billion paying off state employee health insurance bills. The bond issuance raised $6.5 billion in proceeds as the 12-year paper was structured to sell at a premium. The payments allowed the comptroller’s office to leverage more than $1 billion in federal matching Medicaid funds.
The state estimates savings of about $293 million in interest costs for 2018 by trading in a 9% to 12% rate on many of the bills for an all-in borrowing cost of 3.5% on the bonds. S&P said it estimates annual savings of $209 million to $375 million in following years.
Rauner’s finance team highlights the pay down under a section in its recorded investor presentation titled “the state’s credit fundamentals are improving.” Rauner initially resisted tapping the $6 billion in borrowing authorized in the state budget package, calling it a poor solution, but he later moved forward citing the interest savings.
“By the end of fiscal 2018, the bill backlog will be cut in half” to $7.5 billion from the September recorded tab of $15 billion, said state capital markets director Kelly Hutchinson.
The state’s structural budget imbalance only adds to the pressures on the state to meet its pension commitments and S&P worries it “could undermine the state's prospective capacity to reliably fund its retiree benefits liabilities” which analysts view as already at “distressed funding levels.”
The state added another $2 billion to unfunded pension obligations in fiscal 2017, bringing the total to $128.9 billion from $126.5 billion in fiscal 2016. The funded ratio improved slightly rising to 39.9% from 39.2%. The figures are based on the state’s policy that smooths investment results over multiple years.
The budget package smooths the impact of actuarial changes such as changes in assumed rates of return reducing by about $800 million the state’s $8.8 billion contribution this year. The state made $7.8 billion in contributions last year.
Rating factors in the state’s favor include its diverse economy, broad revenue base, sovereign powers to raise revenue and cut spending despite political dysfunction, and the roughly $5 billion in new tax revenue expected annually from an income tax hike included in the budget package.
The state’s GO statutes also are viewed as a strength as they provide an irrevocable and continuing appropriation for all GO debt service and the state funds debt service in advance by setting aside 1/12 of principal and 1/6 of interest every month for payments due in the next 12 months.
In the $4.5 billion negotiated piece of the $6 billion offering, the shortest maturity for three years offered a yield of 2.53%, a 141 basis point spread to the Municipal Market Data’s AAA benchmark. The four year series paid a yield of 2.85%, 161 basis points over the AAA, and the 10-year yield of 3.74% represented a 184 bp spread to the AAA.