CHICAGO – Illinois' economic strengths and fiscal flexibility as a sovereign state won't shield it from further credit erosion, which would move it closer to junk, Moody's Investors Service said in a special commentary.
"The factors that have eroded Illinois' credit standing in recent years could drive the state's credit closer to speculative-grade," Moody's said in a Tuesday report authored by Illinois lead analyst Ted Hampton. "These interrelated factors are governance weaknesses, bill payment deferrals, chronic structural budget gaps, and soaring unfunded pension liabilities."
The commentary seeks to address questions on states' creditworthiness posed by investors since Moody's dropped Illinois one notch to Baa1, three levels above junk grade, from A3 on Oct. 22, primarily due to the five-month-old budget impasse between new GOP Gov. Bruce Rauner and the General Assembly's Democratic majority. As time progresses into the new fiscal year, the window is narrowing for state leaders to tackle a $4 billion to $5 billion deficit or to come up with a plan to address more than $100 billion of unfunded obligations.
The state comptroller has said that billions are being added to the state's bill backlog, putting it on pace to close out the calendar year at $8.5 billion. The backlog was down to about $4 billion several years ago after hitting a high of nearly $10 billion in 2010.
Illinois is the lowest rated state among all the rating agencies. Moody's assigns a negative outlook. Fitch Ratings also recently downgraded the state to the same level at BBB-plus, but assigns a stable outlook. Standard & Poor's has the rating at A-minus on creditwatch.
Illinois benefits from a diverse and wealthy economy, unconstrained revenue-raising powers, and general obligation bondholders enjoy strong legal protections, but "there is no floor for US state ratings, despite states' inherent credit strengths and typically very high ratings," said Hampton, a Moody's vice president and senior credit officer.
Illinois' situation underscores how debt and other pressures can outweigh typical sources of credit strength that protect against default risk, Moody's said. The rating agency assigns most states high grade credits of Aaa or Aa1 that recognize states' powers to cut spending, prudent governance practices, moderate debt burdens, and stable, diverse economies.
While ending the budget gridlock is not likely to "immediately improve the state's credit standing," adopting a budget that moves the state toward balanced operations that can absorb the state's pension funding needs would stabilize and move the state toward an improved credit standing, Moody's said.
On the pension front, any move to cut fiscal 2016 contributions or borrow to cover the payments would pressure the credit because they provide non-recurring relief and add to long term debts, leaving the state all the more vulnerable to shortfalls when the next recession hits.
Rauner and the legislative leaders are scheduled to hold a budget summit on Tuesday, although several have warned that a deal might not be reached until early next year when a new session begins. For legislation to take effect immediately, a simple majority will be needed then, down from a three-fifths majority now needed during a non-regular session. The regular session ended last May. A three-fifths majority would still be needed to override a Rauner veto of action.