CHICAGO – The end of a two-year budget drought in Illinois offers mixed prospects for “downstream” credits that include schools, local governments, transit agencies, and public universities.

Most stand to benefit from the certainty of a budget that assures funding levels, and more timely payments are anticipated from increased tax collections. But some issuers must absorb cuts and uncertainties remain over just how much faster payments can be sped up with the state’s bill backlog at nearly $15 billion.

School district aid also remains up in the air due to a dispute about an overhaul of how aid is distributed and how much Chicago Public Schools should benefit from the proposed changes.

Triet Nguyen, head of public finance credit at NewOak Capital.
"What investors will need to sort out over the next few weeks is what the budget agreement means for all the ‘downstream’ credits," said a NewOak report written by the firm's Triet Nguyen.

“What investors will need to sort out over the next few weeks is what the budget agreement means for all the ‘downstream’ credits such as the city of Chicago, Chicago Public Schools and all the public higher education institutions throughout the state,” said a Friday NewOak MuniCredit Insights report authored by Triet Nguyen, head of public finance credit.

“Although it’s fair to say that the funding issues for many of these entities have been alleviated, the cash flow disruptions from the last two years will take months to be resolved,” Nguyen wrote.

The $5 billion in new annual revenue primarily from an income tax hike, interfund borrowing and possible bonding to pay down the backlog eases the state’s cash crunch, but uncertainties and disparities that trickle down to locals remain, Moody’s Investor Service wrote Friday.

Moody’s has the state’s Baa3 rating on review for a downgrade, a move that anticipated passage of the budget and tax hikes.

“Among the downstream entities affected by the state budget, K-12 public school districts face the greatest uncertainty,” Moody’s wrote.

The budget allows for aid to be distributed only if a shift is made to an “evidence-based” model like the one laid out in a Democratic-sponsored bill that that yet been sent to Gov. Bruce Rauner’s desk. Rauner has threatened a veto calling it a CPS bailout because it provides nearly $300 million in additional funding for the cash-strapped Chicago school district.

Rauner on Monday called on the Senate to send the school funding overhaul bill to him and said he would use his amendatory veto to alter it to his liking. CPS would receive about half of the extra $300 million aid in the original bill under Rauner’s plan.

The first school aid payment is due early next month. “School districts with relatively low property tax wealth or high poverty face the greatest risk from a disruption in state funding because of their material dependence on state aid,” Moody’s warned.

CPS is most at risk due to its own liquidity ills and any failure to resolve the state aid distribution issues “would severely weaken CPS's already dire financial position,” Moody’s said.

Moody’s previously announced a review of CPS’ junk rating for a downgrade over its state exposure. That also prompted a review of Chicago’s junk rating because of the city's exposure to the district’s strains and a pledge to help.

Passage of the budget does represent a positive for CPS and others that rely heavily on special grant funding which has seen long delays in payment.

At the university level, the budget provides some immediate liquidity relief even with a 10% cut from fiscal 2015 funding levels. The comptroller’s office recently released $523 million in payments that will come from existing non-general fund education accounts.

“Public universities will continue to confront material challenges that linger following multiple years without a full budget,” Moody’s wrote. Universities received only 50% of their expected funding in fiscal 2017 which drove some to cut programs and lay off staff. “Illinois public universities’ competitive positions have been impaired due to reputational damage,” the report said.

Local transit agencies will benefit from more “steady and rapid” matching aid payments, Moody’s said. The current backlog owed to the transit agencies, primarily the Regional Transportation Authority of Illinois, is $643 million. The transit agencies, however, must absorb a slight cut.

At the local government level, municipalities face cuts but on balance the budget is favorable as it reduces uncertainty regarding funding. The primary hit will come from a new 2% fee the state will deduct from sales taxes it collects and distributes to cities and counties.

Moody’s has raised deep concerns over the state’s long-term prospects for holding down its bill backlog to manageable levels and the lack of any concrete measures to rein in a $126.5 billion unfunded pension tab.

Those are concerns raised across the municipal market.

“Although the market’s anxiety about a potentially historic downgrade of a major state to below investment grade may be assuaged for the time being, the fundamental credit issues that have been raised by Illinois’ protracted budget battle will certainly haunt the municipal market at large for quite a while longer,” NewOak wrote.

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