J.B. Pritzker won over Illinois voters in November to claim the governor's office. Now he faces a referendum from a different audience — the municipal bond market.
The state will take competitive bids Tuesday on a $300 million of taxable new money to finance pension buyouts and a $152 million tax-exempt refunding series. The results will offer insight into whether investors buy into Pritzker’s argument that his pension, budget, and graduated income tax proposals lay the groundwork to stabilize the state’s rocky fiscal foundation.
Market participants cautioned that the test will be limited as scant supply and strong demand across the market will help the state's case.
The governor took his appeal directly to investors in between meetings with rating agencies in New York City March 11. The state’s bond ratings — so low that a cut to junk is in the realm of possibility — were among the topics investors brought up, along with Pritzker's proposed pension fixes, legislative relationships, and spending and revenue priorities.
“My highest priorities as governor are stabilizing our state government, growing the Illinois economy and protecting working families,” Pritzker said at the
Pritzker defended his proposals, which depend on winning voter approval in November 2020 for a constitutional change allowing the state to shift to graduated income tax rates from a flat one. “My proposed fiscal 2020 budget serves as a bridge to a stable fiscal future,” he said.
Before then, however, the state must close a $3 billion deficit in fiscal 2020. It also faces an unpaid bill backlog that sits at about $8.7 billion as of Tuesday, and rising payments on a $133.7 billion of unfunded pension liabilities.
Pritzker has laid out a proposed tax structure that raises income tax rates on only the top 3% of earners, a structure he hopes will sway lawmakers and voters. Pritzker’s five-piece pension plan, that provides $1.1 billion in near-term contribution relief mostly from extending the current statutory contribution schedule by seven years, faces pushback from analysts and investors because of fears it could trigger a downgrade.
One participant in the investor meeting asked the new governor if he was willing to back off on the near-term pension funding cut.
Pritzker said his plans are not “stuck in cement” but he stressed that they are part of a package.
“This is not a menu of items from which to choose and it’s only a beginning,” Pritzker added. He defended the near-term relief as a means to avoid “crowding out investments” that hurt economic growth, with future pension boosts coming from asset transfers and graduated tax revenue.
Pritzker took questions about his commitment to holding on to the state’s investment grade rating and whether rating agencies offered any signals during their earlier meetings.
Pritzker stressed that his presence in New York displayed his interest in building good investor and rating agency relationships and he largely sidestepped a question as to whether he would back off at least the re-amortization due to negative rating agency comments.
"I think there's a better understanding because we've had meetings," Pritzker said of the rating agencies. “They were good constructive conversations. … I hope at least from your perspective ... that the issue of stability is paramount and something that I'm very focused on."
Pritzker also drew distinctions between him and his predecessor, Republican Bruce Rauner, on both his attempts to shed the political acrimony of the last four years that drove the state’s two-and-a-half-year budget impasse and on his respect for the municipal bond market.
“I think it’s been a mistake frankly for governors not have come to speak with you and speak with the rating agencies about Illinois,” Pritzker said, adding of Rauner, “he didn’t care about the state’s credit rating and I think he proved it during his tenure in office."
“My view is that I will advocate for the state of Illinois wherever I can, especially to those who consider investing in it, and that’s why I’m with you today,” Pritzker added.
Pritzker told investors he plans to direct new spending on public education, strengthening the human services safety network, reforming criminal justice, and addressing the 10-year drought with a major infrastructure program.
Pritzker also faced a question about why he opposes allowing a second question to appear on the November 2020 ballot asking voters to ease the state constitution pension clause’s ironclad protection of benefits.
“Here’s the fact, even if you went after that and got it passed ... you’d very likely end up with a court challenge because it may violate the contracts clause of the U.S. Constitution and what would inevitably happen is you end up in a court challenge,” Pritzker said. “My guiding principal is the courts have ruled.” Pritzker was referring to Illinois Supreme Court decisions in recent years that ban impairment of promised benefits.
The governor, whose fellow Democrats enjoy supermajorities in the legislature, acknowledged the political push needed to adopt a graduated income tax. He will need most Democrats to support him to reach the 60% threshold to put the measure to voters. The amendment becomes effective if approved by either 60% of those voting on the amendment or a majority of those voting in that election.
Pritzker was non-committal on a question about his commitment to future funding increases for pensions. “I think that’s a good beginning,” he said of the $200 million from a graduated tax, saying that additional revenue would allow for a future debate.
Future asset sales and transfers could yield “hundreds of millions” in the near term and “billions over the long term.” Pritzker said he expected the ideas now being reviewed by a special task force should yield results by the end of July.
DEAL
The new money portion of next week's deal has a final maturity in 2044; the refunding in 2028. State GO paper in the 10-year range has been trading at a 183 basis point spread to the Municipal Market Data top-rated benchmark and 172 basis points on the long end.
Budget director Alexis Sturm and capital markets director Kelly Hutchinson laid out the budget and pension proposals for potential investors in a recorded presentation. Financial data supporting the bonds includes the availability of $12 billion in non-general funds if needed for debt service and the fixed-rate structure of all $27.8 billion of the state’s GOs.
The state also will see a reduction in debt service of $953 million to $3 billion annually this fiscal year as 2011 pension bonds are retired. While the new money is financing pension buyouts, the state can’t yet say by how much the buyouts will reduce the unfunded tab.
The offering statement also discloses that the bailout cost of the state’s troubled prepaid college program could carry a price tag in excess of $500 million between 2026 and 2053 if no new contracts are struck. Pending legislation shift to a full faith and credit pledge from a moral obligation and would end the program.
Columbia Capital Management LLC and Sycamore Advisors LLC are advising the state. Chapman and Cutler LLP and Charity & Associates PC are bond counsel.
Since the governor's meetings, the rating agencies have affirmed the state’s ratings: BBB with a negative outlook from Fitch Ratings, Baa3 with a stable outlook from Moody’s Investors Service, and BBB-minus with a stable outlook from S&P Global Ratings.
Their reports provide additional clarity on the state’s rating prospects and what headwinds could trigger downgrades. Fitch Ratings is the most clear about the threat posed by the budget.
Fitch warned of a downgrade “if the state exacerbates its structural budget challenges, through measures such as materially increasing the burden posed by its accounts payable balance and other liabilities during a period of ongoing economic growth.
“Elements of the governor's fiscal 2020 executive budget proposal, including a largely unresolved 2019 deficit and numerous one-time measures in fiscal 2020, appear to do that,” Fitch wrote.
Alone, the re-amortization might not to drive an S&P cut to junk. “It remains possible that an asset transfer or passage of an income tax increase within the outlook horizon could offset what we would otherwise view as weak budgetary practices proposed in the fiscal 2020 budget,” S&P analyst Carole Spain said.
Liquidity is a sticking point and “downward rating pressure would likely ensue if Illinois' bill backlog continues to climb,” S&P said.
“Given its tenuous fiscal position, near-term progress toward resolving its ongoing structural imbalance is critical to maintaining our investment-grade rating. If Illinois is unwilling or unable to pass a revenue increase within the next two years, absent significant expenditures cuts, we would likely lower the rating,” S&P said.
Moody’s is reserving judgment on the credit profile until a final budget is passed, saying that action on various initiatives in coming weeks could affect the state's credit standing.
Factors that could drive a downgrade to junk include renewed growth in payment backlog that reverses progress and a reduction in pension contributions for fiscal relief. Moody’s does not say if the governor’s pledge to bolster pensions with asset transfers and graduate tax funds would offset the reduction in 2020 contributions.
