CHICAGO – The municipal market rewarded Illinois lawmakers Wednesday for passage of a budget package that would end two years of budget gridlock, even though a House override of Gov. Bruce Rauner’s veto is still needed and junk status looms if it fails.

The vote is the one hurdle that remains to end two years of historic budget gridlock that has left Illinois’ ratings on the verge of junk.

The House will attempt Thursday to override Gov. Bruce Rauner’s Tuesday veto of a $36 billion fiscal 2018 budget package. The Senate passed the package Tuesday, Rauner vetoed it, and senators then overrode the veto.

Michael Madigan, speaker of the Illinois House of Representatives in Springfield, Illinois on Feb. 18, 2015.
Illinois House Speaker Michael Madigan will attempt on Thursday to override Gov. Bruce Rauner's vetoes of a budget package.

“The House will hold a vote on Thursday, July 6 to override the governor’s vetoes of the balanced budget sent to him," Speaker Michael Madigan, D-Chicago, said Wednesday. "House Democrats look forward to working with our colleagues on the other side of the aisle to begin healing the wounds of the last several years,”

Illinois general obligation spreads to the Municipal Market Data’s AAA benchmark tightened between 40 and 55 basis points on maturities beginning in 2021.

“There has also been a similar movement in Chicago GO spreads,” said MMD strategist Daniel Berger. On Monday, the Illinois’ 10-year was trading at a spread of 278 basis points. It was at 240 basis points before June 1 downgrades.

“We are seeing a huge bump in Illinois State paper,” said Edward Lee at IHS Markit. A 2032 bond with a 5% coupon landed at a yield of 4.62 %, down from a previous trade of 5.21%, while a 2025 bond traded at 4% down from 4.43%. Chicago saw its spreads narrow by about 20 basis points to 242 basis points on a 2040 bond with a 5% coupon.

Several market participants cautioned against reading too much into the movement.

“The tightening trades are speculative, due to the uncertainty around the veto, and the veto override,” said Brian Battle, director of trading at Performance Trust Capital Partners LLC. “These trades are betting the tax increases will be in effect. Tomorrow should be determinative if the tightening trend sticks.”

Two rating agencies weighed in on Monday, saying the package, if it becomes final, represents progress toward stabilizing the state’s rocky finances.

Passage of the legislation "represents a meaningful step toward the enactment of a comprehensive budget for fiscal 2018,” wrote S&P analysts Gabriel Petek and Eden Perry. S&P rates the state BBB-minus and has the rating on watch.

S&P had made clear in previous commentaries that the state faced the prospect of being the first to land in junk territory because of its structural deficit and the magnitude of its unpaid bills. A court order Friday that requires the state to bolster monthly Medicaid voucher payments by $586 million “threatens to provoke a liquidity crisis,” S&P said.

Fitch Ratings called the developments "concrete progress on reaching an agreement to break the two-year long budget impasse." Fitch, too, rates the state BBB and has it on watch.

Moody’s Investors Service rates the state at the lowest investment grade level of Baa3 with a negative outlook.

THE VOTES

The Senate’s narrow override of Rauner’s veto on the July 4th holiday capped a five days of action that came in fits and starts, beginning with an initial budget vote in the House Friday that cleared with strong bipartisan support.

Talks then broke down on a final agreement, but Madigan brought the package’s three bills up for a vote Sunday. They narrowly passed with the required three-fifths majority after 15 Republicans broke ranks with Rauner and joined the Democratic majority.

Action moved to the Senate on Tuesday where one GOP member joined with the Democratic majority to reach the needed three-fifths majority for the tax bill to take effect immediately and survive the threatened veto.

The votes came without a final agreement on issues like worker’s compensation reforms and a local property tax freeze sought by Rauner as part of a final deal with tax hikes, so most GOP members withheld their support. Rauner moved quickly to veto the bills.

“The package of legislation fails to address Illinois’ fiscal and economic crisis – and in fact, makes it worse in the long run,” Rauner said in his veto messages. “It does not balance the budget. It does not make nearly sufficient spending reductions, does not pay down our debt, and holds schools hostage to force a Chicago bailout.”

Rauner charged that even with “the Madigan permanent 32% income tax increase, this budget remains $2 billion out of balance for fiscal year 2018” and “will require even more tax hikes to balance the budget and pay down the bill backlog.”

The Senate moved quickly on override votes Tuesday.

“We formally move to override this veto motion to make sure that when the markets open tomorrow that we are not the first state in the history of the United States to reach junk status,” said Sen. Toi Hutchinson, D-Olympia Fields.

“We still need to address the high property taxes in Illinois, and the burden they place on people and job creators in this state. We still need to address workplace reforms that will bring jobs to and keep jobs in Illinois,” said Minority Leader Sen. Bill Brady, R-Bloomington.

The House lacked the members needed to follow the Senate's lead, so it put off a vote until Thursday. To succeed, Democrats will need to hold on to most of the 15 GOP members that broke ranks.

Democrats hold 67 seats and Republicans hold 51 in the House with 71 needed for legislation in a post-regular session to take effect immediately or for an override. Senate Bill 9, the tax bill, cleared in a 72-45 vote. The bill got 15 GOP votes while 10 Democrats voted against it. The vote on the budget appropriations Senate Bill 6 followed and passed with a higher margin in an 81-34 vote and the budget implementation bill laid out in Senate bill 42 passed with 73 votes.

BUDGET

The package calls for spending $36.1 billion, which backers highlight is less than the $37.3 billion proposed by Rauner earlier this year. They also highlight that much of it was crafted through bipartisan negotiations.

The plan trims $2.5 billion in spending, including a 5% cut in state agency costs, with higher education taking a 10% hit. It relies on $1.5 billion in savings from pension changes, many of which were proposed by Rauner. They limit end-of-career pension spiking and phase-in accounting for actuarial changes.

The plan also implements a Tier 3 defined benefit and defined contribution pension plan for current Tier 2 members It doesn't include the so-called consideration pension reform model that asks employees to accept cuts in exchange for other benefits. It’s estimated to save $1 billion annually, though it would face a legal challenge.

The package provides an additional $350 million for kindergarten-through-12th grade but it allows the state to distribute aid only through a new formula such as one outlined in a pending education funding overhaul bill Rauner has threatened to veto. Chicago Public Schools stands to gain about $300 million in new pension funding help and additional operating aid.

The package authorizes $6 billion in general obligation-backed cash flow borrowing to pay down the nearly $15 billion bill backlog. Through various non-general fund sweeps, a projected revenue surplus, and tapping matching federal Medicaid dollars the state could bring its backlog down by as much as $8 billion, backers say.

The tax package raises more than $5 billion in new revenue. It lifts the personal income tax rate by 32% to 4.95% from 3.75% to generate $4.45 billion annually and the corporate income tax rate would rise to 7% from 5.25% to generate $514 million. Closing some corporate tax loopholes would raise another $125 million and a sales tax discount for ethanol blended gasline would be dropped to generate $100 million.

The state currently spends about $39 billion while collecting just $32 billion to $33 billion.

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