Illinois sales tax bond rating takes a five-notch hit

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CHICAGO – Illinois’ sales tax-backed bonds took a five notch hit from S&P Global Ratings as a result of revised criteria published last week that more closely tie priority-lien tax revenue credits to their government issuer.

S&P downgraded Build Illinois bonds to BBB from AA-minus Tuesday. The rating agency had rated them AAA until dropping them to AA-minus June 2017 despite healthy coverage ratios, because of increasing concerns that the flow of pledged revenues could be diverted as the state barreled toward a third fiscal year without budget.
S&P rates Illinois’ general obligation bonds BBB-minus, the lowest investment grade, with a stable outlook. The budget impasse ended in July 2017 although state finances remain deep in the muck over a $129.5 billion unfunded pension tab and $7 billion bill backlog.

About $2.5 billion of senior and junior lien bonds are impacted by the downgrade, including $250 million that sold ahead of the revised criteria published Oct. 22.

S&P is reviewing all ratings with a priority on those issuers that are in the market, said S&P’s lead Illinois analyst, Gabriel Petek. The new criteria was published after the sale, “but in the interest of providing as much transparency as we can,” the review was conducted and downgrade published ahead of the upcoming closing of the bonds.

“Given the S&P’s announcement of its new rating ‘criteria,’ it is not unexpected,” said Gov. Bruce Rauner’s spokeswoman, Patty Schuh.

The ongoing S&P criteria change process was disclosed in the offering documents for the Oct. 22 bond sale.

In May, Fitch Ratings cut the credit five notches to A-minus from AA-plus following a revision to criteria for state dedicated tax bonds that limits the situations in which a state's dedicated tax security can be rated without regard to the state's general credit quality. Fitch rates Illinois’ GOs BBB with a negative outlook.

Ahead of the October deal, Illinois added Kroll Bond Rating Agency to the ranks of Build Illinois raters. Kroll assigns its AA-plus rating to the Build Illinois program. Moody’s was not asked for ratings. It has long linked the sales tax and GO ratings.

The downgrade did not seem to have an immediate impact on sales tax bond trading levels Wednesday, Municipal Market Data senior municipal strategist Daniel Berger said early in the day. “Thus far, we are not seeing any trading of this name (IL Sales Tax) today,” he said. “However, we have seen weakening of IL GOs by about 5bps. The general market is about 3-4bps lower.”

Based on the revised S&P criteria the sales tax bonds are capped at one notch above the state’s GO rating.

"The downgrade reflects our view of the state's general creditworthiness, which, under the new criteria, limits the final ratings on priority-lien tax revenue debt," Petek said. “Our priority-lien criteria takes into account both the strength and stability of the pledged revenues, as well as the general credit quality of the obligor where taxes are distributed and/or collected, in this case, the state of Illinois.”

The structure with double-digit coverage ratios, limited ability for future issuance, and sound annual growth would warrant a higher rating on its own but the program’s structure lacks firm provisions that would protect against a future state weakening of the credit, resulting in the one-notch cap.

Under the revised criteria, a true sale of pledged revenues like Chicago’s sales tax securitization bonds would reduce the impact to a four-notch cap above the government obligor’s rating and provisions such as an intercept or lockbox on revenues would allow for a two-notch cap.

The Build Illinois bonds “get kneecapped by the state” based on the structure and relationship to the state, Petek said.

“In our view, the inability to prohibit future lawmakers from taking such action, combined with the state's unresolved fiscal imbalances, links the credit quality of the Build Illinois sales tax revenue bonds to the state's general creditworthiness,” the report said.

Illinois drew strong interest on the competitive sale but paid a higher interest penalty compared to its previous Build Illinois outing in 2016.

The 10-year maturity in one insured series landed at a 3.50% yield, 77 basis points over the MMD AAA benchmark and five basis points below the BBB benchmark. The 10-year in one series landed at a yield of 3.62%, 89 bp over the AAA and seven bp more than the BBB. The 10-year in the state’s 2016 sale for $549 million landed at 1.88%, a 47 bp spread to MMD.

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Ratings Secondary bond market Sales tax State of Illinois Illinois