CHICAGO – Illinois bonds saw another price bump in trading that followed Moody’s Investors Service’s decision to keep the state in investment grade territory after its review of the new fiscal 2018 budget package.
The state remains on the verge of junk status at Baa3 with a negative outlook based on the rating confirmation Thursday. S&P Global Ratings also has the state’s general obligation bonds one step away from a speculative grade rating but earlier this month moved its outlook to stable from negative. Fitch Ratings previously affirmed the rating at BBB with a negative outlook.
One block of 2029 bonds traded Friday at a 175 basis point to 180 bp spread to the Municipal Market Data’s top benchmark. The bonds had previously traded at a 200 bp to 205 bp spread, said Greg Saulnier, an MMD analyst.
It’s not yet clear whether the tightening is a reaction that will hold steady in coming days.
“Secondary flows being so thin given typical summer Friday participation, we are waiting for more consistent evidence to develop before changing our IL GO spreads accordingly,” Saulnier said. "Activity should pick up next week and tell us if there is meaningful spread compression
IHS Markit's Edward Lee said he observed Friday trades that reflected an 18 basis point narrowing of spreads.
The state has seen steep tightening that previously came in two waves during the Fourth of July holiday week. Spreads narrowed on July 5 by 40 to 55 basis points after positive budget developments in the Senate a day earlier. The second came Friday July 7 after the House finished the job of enacting the state's first budget in more than two years by narrowly overriding Gov. Bruce Rauner's override. Spreads again narrowed from 13 basis points on the 10-year to as much as 20 to 40 basis point on other maturities.
Rating pressure had eased on the state as the budget developments unfolded with positive initial assessments from Fitch and S&P, but Moody’s put Illinois on review for downgrade despite the expected end to the two-year impasse with a plan that raises $5 billion in taxes.
Moody’s had warned that the budget failed to put a dent in the state’s $126.5 billion pension tab, did nothing to prevent a further buildup in the nearly $15 billion backlog, and faced implementation risks due to Rauner’s opposition.
Many market participants believed Moody’s would drop the state to junk. Some expressed opinions that it was clearly warranted while others thought the tax hikes and spending cuts should fend off immediate action.
Triet Nguyen, head of public finance credit at NewOak Fundamental Credit, felt a downgrade to junk was warranted.
“We were disappointed, but not surprised,” he said. “At the end of the day, we believe Moody’s does want to give the state the benefit of the doubt, however this sends the wrong message to the state legislators. They’ll probably conclude that raising taxes without structural reform was all they needed to do to preserve the rating.”
Moody’s summed up its decision to hold the rating steady saying “passage of budget legislation that alleviates immediate liquidity pressures, moves the state closer to fiscal balance and should keep pension and other fixed costs at manageable levels at least in the near term.” The state spent $6.6 billion more than it collected in revenues in fiscal 2017.
The state's underpin huge pension burden and the state's deep stack of overdue bills warrant the negative outlook, Moody's said.
“Reducing and containing the backlog over the long term will likely depend on repeated operating surpluses, which the state has not produced in recent memory,” Moody's analysts wrote.
Using its own calculations, Moody’s puts Illinois’ adjusted net pension liabilities at $251 billion, which as a share of revenue is five times the Moody’s state median.
While no other state has engaged in payment deferrals to a comparable degree, Moody’s said the credit significance for Illinois is partially offset by about $11 billion in available cash in various non-operating funds.
Governance flaws also do little support Illinois, Moody’s noted. The state does not adhere to a binding revenue consensus forecast, doesn’t maintain a significant rainy day fund, and constitutional budget-balancing requirements are not enforced or meaningful.
“The state’s shortcomings in these respects have contributed materially to its credit deterioration in recent years,” Moody’s wrote.
"It's hard to disagree with many of the points Moody's makes," said John Patterson, a spokesman for Senate President John Cullerton, D-Chicago. "Looking forward, the Senate President knows more work is needed to continue to shore up our financial stability and keep Illinois moving in a positive direction.”
The Rauner administration, which opposed the budget because it lacked a local government property tax freeze or worker’s compensation changes, said the rating update “only shows how much work we still have ahead of us.”-