CHICAGO — A downgrade to junk would mean Illinois faces termination events on some swaps tied to $600 million of floating-rate paper while any rating cut would raise its interest fees.
The $600 million from a 2003 issue and its related swaps represent just a small piece of the state’s $26 billion general obligation debt portfolio, and any added costs may not seem like much, particularly in the context of the state government's $14 billion backlog of unpaid bills. But it adds to the list of consequences the state could face if its historic budget impasse drags into a third fiscal year July 1.
“With the end of the Illinois General Assembly legislative session looming and a budget compromise still out of reach, the potential for ratings downgrades once again threatens to trigger termination of Illinois’ interest rate swap agreements, which would cost taxpayers tens of millions of dollars,” the Chicago Civic Federation’s Institute for Illinois’ Fiscal Sustainability wrote in a Friday report about the swaps.
Rating agencies have warned that the Illinois must demonstrate progress in righting its fiscal ship to avert further downgrades. Whether rating agencies would drop the state's GOs one notch to the lowest investment grade level or go further is unknown.
Illinois is the lowest rated state and no state has ever been rated junk.
The legislative session formally ends May 31 after which a three-fifths majority vote is required for legislation to take effect immediately. It’s unclear whether Gov. Bruce Rauner, a Republican, and the legislature’s Democratic majorities will soon resolve differences that have left Illinois without an operating budget since July 2015.
The state announced last fall that it had renegotiated its five interest rate swaps, which included the novation of two, to lower the ratings thresholds that would trigger termination events.
The five swaps are with four counterparties and bear an interest rate of 3.89%. They were negatively valued at $153 million at the time but the Civic Federation said it was told earlier this month by state finance officials that the negative valuation stood at $107.9 million as of March 31.
Barclays is counterparty to two swaps each for $54 million, Bank of America on $54 million, JPMorgan Chase on $54 million, and Deutsche Bank on $384 million.
Terminations would be triggered on the Barclays, JPMorgan, and BofA swaps if the state’s rating from Moody’s Investors Service or S&P Global Ratings falls to junk.
The state has more breathing room on the largest amount with the trigger set a further notch lower on the Deutsche Bank swap.
The Rauner administration said at the time the state pays a total in interest and fees of 6.79% on the bonds.
Last fall, the state also remarketed the floating-rate paper in a direct placement with four banks. The bonds bear either a LIBOR or SIFMA-based interest rate with a mandatory tender date of Nov. 7, 2018.
DNT Asset Trust accounts for $226 million, PNC Bank NA accounts for $224 million, State Street Public Lending Corp. accounts for $75 million, and RBC Municipal Products LLC accounts for $75 million. The first three bear an interest rate of 70% of 1-month LIBOR and the fourth is based on SIFMA.
The state pays a fixed interest spread fee of 2.95%. The state reported in an amended May 9 disclosure filing on the direct placement that the 2.95% spread rises to 3.45% if one of its ratings dropped to Baa3/BBB-minus. If one of its ratings falls to junk the fee increases to 5.45%. If at least two drop the state to junk, the spread rises to 645 basis points. If any of its ratings fall to Ba2/BB, the spread jumps to 745 bp.
While not imminent, the two-year term looms on direct placement.
“The agreements will expire in November 2018, and if the state’s ratings do not improve by that time it could face additional costs as well as the risk that it cannot find anyone willing to ‘rollover’ the bonds,” the Civic Federation noted.