Moody's Drops Illinois to A1 From Aa3

CHICAGO - Ahead of Illinois' $150 million general obligation sale tomorrow, Moody's Investors Service delivered the latest in a series of fiscal blows to the state's credit when it knocked the rating into the single-A category due in part to plans for $2.3 billion of deficit borrowing.

Illinois now joins Louisiana in the the high single A-category among states. Only California is rated lower by Moody’s – at the A2 level – while all other states rated by the agency are in the double-A category. Fitch Ratings downgraded the state one notch to AA-minus last December and Standard & Poor's in March also knocked the credit down one notch to AA-minus.

The downgrade to A1 from Aa3 adds to the burden inherited by Gov. Pat Quinn, the former lieutenant governor who took over after the General Assembly removed Rod Blagojevich from office for abusing his power.

The former governor was arrested in December on corruption charges and was formally indicted Thursday by a federal grand jury charging him and five associates with using the governor's power to influence legislation, jobs, and contracts for personal profit.

Quinn took over a state that is now grappling with a combined $12 billion deficit in the current and next fiscal years. He has proposed a $52.9 billion budget for fiscal 2010 that would eliminate the deficit using federal stimulus funds, spending cuts, an income tax increase, $2.2 billion of debt restructuring, a cigarette tax increase, and trimming scheduled pension payments.

To help manage through the deficit and pay down bills, Quinn's finance team has proposed the short-term borrowing that would not be repaid until the next fiscal year - a practice referred to as deficit borrowing, which provides analysts with one of the clearest indications of a government's fiscal stress. That, along with other strains on the state's finances, triggered the downgrade.

"We are obviously watching the state's operating liquidity, and the proposal to essentially roll over short-term debt into the next fiscal year increased our concerns," said Moody's analyst Ted Hampton. "We've also been concerned about pension funding, and while the governor has proposed meaningful reforms, we have concerns about the potential use of pension fund deferrals to help cover current obligations."

The governor wants to trim $2.8 billion off planned pension payments, arguing the move is warranted given the long-term savings that would occur by cutting benefits for new employees. The unfunded pension liability has grown due to the market's downturn to $74 billion from $54 billion just two years ago.

Late last month, Quinn filed a notice with the General Assembly of the state's intention to do two short-term borrowings totaling $2.3 billion before the current fiscal year ends June 30, with repayment not planned until the next fiscal year. The proceeds would be used to pay down the state's $3 billion backlog of bills.

Under the state's short-term borrowing laws, traditional cash-flow issues must be repaid in the same fiscal year. The governor is tapping a provision that permits notes to be repaid within 12 months of their issuance in the event of a "failure of revenues." The notice reports that revenues in the current fiscal year are expected to fall at least $3.2 billion below original budgeted estimates.

State debt manager Phil Culpepper said yesterday the timing and structure of the two issues are still being decided as the state works with Comptroller Daniel Hynes and Treasurer Alexi Giannoulias - both of whom must approve any short-term financings. Hynes late last year suggested such a move to address the bill backlog.

Budget office spokeswoman Marcelyn Love countered that the rating action doesn't fully recognize Quinn's efforts to deal with an unprecedented fiscal crisis. "The governor is proposing a budget that will greatly improve the state's financial situation ... On every major fiscal issue Gov. Quinn is taking aggressive action that will get Illinois back on long-term, sound financial footing," she said.

Moody's Hampton said the rating action is not a reflection of the new governor's budget, but rather the severe strain on the state.

"We think that the new governor has a lot on his plate and has been courageous in proposing some changes such as the income tax increase," he said. "It's not a judgment on the budget proposal as much as on the severity and weight of problems that have built up and are coming to bear on the state at a difficult economic time."

The downgrade followed Moody's action last December to strip the state of its top short-term credit marks ahead of a $1.4 billion cash-flow borrowing. That move - along with news of Blagojevich's arrest - cut deeply into broker-dealer interest in the deal as any further downgrade would prohibit money market funds from holding the securities.

The state could face the same lack of interest with the new short-term issues, but officials are banking on the market's improving stability since December. With the promise of a significant jump in borrowing expected if a $26 billion capital budget is passed, broker-dealers might also be more willing to bid in an effort to curry the state's favor in hopes of winning negotiated bond deals, sources said.

The state's deal tomorrow represents its first new-money issue since last April. The proceeds will pay for capital projects previously approved by the General Assembly. D.A Davidson & Co. is financial adviser and Barnes & Thornburg LLP is bond counsel.

Amid ongoing efforts to pass a capital budget, the legislature in a bipartisan vote on Thursday adopted a smaller version that calls for $3 billion of borrowing over the next five years to finance transportation and transit projects.

"We are still pursuing the Illinois Jobs Now package, but the idea with the smaller bill was to jump-start the economy by moving forward with shovel ready projects and leveraging federal funds," Culpepper said. Quinn on Friday signed the package.

Senate Republican spokeswoman Patty Schuh praised the passage of the capital budget, but said the downgrade and short-term borrowing are examples of how mismanagement during Blagojevich's six-year tenure has hurt the state and that "it's the appropriate time to make significant reforms in state spending and service delivery, not to turn to tax increases."

The downgrade impacts $19.4 billion of GO debt, including $10 billion of taxable pension bonds, although the global rating of Aa2 remains intact. Another $2.1 billion of sales-tax backed Build Illinois bonds were downgraded to A1 from Aa3, and the Metropolitan Pier and Exposition Authority's $2.1 billion of bonds were downgraded to A2 from A1.

Other factors contributing to the downgrade included "governance shortcomings such as chronic delays in financial reports, a protracted record of negative operating fund balances, and weak economic performance in recent years," Moody's wrote.

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