CHICAGO – Illinois could still see its general obligation rating cut to junk even if the House succeeds in overriding Gov. Bruce Rauner’s veto of a $36 billion budget package that includes spending cuts and $5 billion in new revenue.
Moody’s Investors Service on Wednesday put the state’s Baa3 rating under review for a possible downgrade due to its failure to enact a timely budget for fiscal 2018, which began July 1, and its “failure to achieve broad political consensus on how to move toward balanced financial operations.”
“The review will provide a limited amount of time for the Illinois General Assembly to finish voting on the measures, and for assessment of the plan's credit implications. The review process will also address the likelihood of further deterioration in Illinois' most pressing credit challenges: its severely underfunded pensions and a backlog of unpaid bills, which has doubled during the past year,” Moody’s wrote.
On both fronts, Moody’s raised questions while also saying the partisan path to passage is a concern.
The review applies to the state’s $32 billion of rated general obligation and sales tax-backed Build Illinois bonds, appropriation-backed civic center and Illinois Metropolitan Pier and Exposition Authority bonds. The appropriation bonds are rated at the junk level of Ba1.
The legislature’s passage of a budget package over the long holiday weekend and then the Senate’s successful override of Gov. Bruce Rauner’s veto buoyed the market, narrowing yield penalties by 40 basis points to 55 basis points as it appeared two years of gridlock was near an end.
The House must hold on to the more than dozen GOP votes that broke party ranks to approve the package in an override attempt slated for Thursday.
Lawmakers spoke of the need to pass the plan sooner rather than later to avert a historic fall by a state to a speculative grade rating. Moody’s launch of the review hits back hard against those arguments to pursue passage before a fuller, bipartisan deal was reached.
The review incorporates the expectation that the override will succeed and tax hikes will take effect. Moody’s said the plan has implantation risks given the partisan political divide that remains.
“Despite the progress toward budget balance that the emerging fiscal plan embodies, the plan entails substantial implementation risk” given its mostly party-line support, Moody’s said. “The plan therefore appears to lack broad bipartisan support, which may signal shortcomings in its effectiveness once implemented.” Ted Hampton is Moody's lead Illinois analyst.
“So far, the plan appears to lack concrete measures that will materially improve Illinois' long-term capacity to address its unfunded pension liabilities,” Moody’s wrote.
The state has a $126.5 billion unfunded pension tab. Before the budget gridlock, rating agencies had long cited the growing tab and rising contributions that will consume more than $8 billion in revenue in fiscal 2018 as the biggest drag on the state’s credit profile.
The package anticipates $1.5 billion in annual savings from various pension changes but lacks the so-called “consideration” model that could save about $1 billion annually by asking employees to accept cuts in exchange for the benefit of future raises being counted toward their pensionable salaries. The plan, if eventually adopted, would face a legal challenge.
The state’s troubled liquidity also will weigh heavily in the review. The state’s cash flow struggles grew all the more precarious on Friday when a federal judge ordered the state to raise its Medicaid payments by nearly $600 million monthly and to pay down $2 billion in overdue bills over the course of the fiscal year.
The decision “cast doubt on the state's immediate ability to keep up with its statutory pension contribution schedule while also meeting obligations for debt service, payroll and school funding,” Moody’s wrote.
Moody’s has concerns over the budget package’s reliance on up to $6 billion of borrowing “that probably will rank among the largest in the state's history,” analysts wrote.
“This component of the state's broader fiscal plan leaves Illinois not only dependent on market access to ease liquidity pressures, but also facing a significant increase in its tax-supported debt burden,” Moody’s added. “Moreover, the effectiveness of the state's strategy to contain and reduce its deferred bills, once the backlog-financing debt has been issued, remains to be seen.”
Also, analysts are concerned about the state’s decline in baseline tax collections in fiscal 2017 according to the latest reports from the legislature’s Commission on Government Forecasting and Accountability which suggest that the proposed tax increases may yield less revenue than anticipated in coming months.
Moody’s places ratings on review when a rating action may be warranted in the near term, but when further information or analysis is needed to reach a decision. A majority of reviews are concluded within 30 to 90 days, Moody's said.