CHICAGO – Before the ink dried on Puerto Rico’s bankruptcy-like Title III petition last week, talk turned to Illinois and whether it could eventually land in a court-supervised forum to deal with its mounting debts.

The state is nearing two years without a budget, an impasse that has put its investment-grade ratings at risk as it struggles under the weight of a $5 billion deficit, $13 billion of unpaid bills and $126.5 billion of unfunded pension obligations.

The U.S. territory’s filing immediately prompted speculation as to whether such an avenue could be eventually be established for Illinois.

But it’s a long leap to make, market participants say, given the political, legal, and constitutional obstacles that prevent any form of bankruptcy filing by a sovereign state and the enormous gap in the level of distress between the two entities.

Puerto Rico oversight board member David Skeel speaking at a forum in Philadelphia on the same day Puerto Rico filed under Title III of the Puerto Rico Oversight, Management and Economic Stability Act, brought up Illinois in a discussion of allowing state bankruptcies.

“I think that’s the strongest argument against state bankruptcy, that you don’t need it at the end of the day. Illinois at some point is going to realize that they have to have a budget as much as they hate each other and they’ve got to do something about their problems,” said Skeel, a University of Pennsylvania law professor and bankruptcy expert.

He added that on the plus side “state bankruptcy would enable you to restructure some obligations that are currently not restructurable” like Illinois pension obligations, given its strong state constitutional protections against benefit cuts.

“Puerto Rico is the terrifying Ghost of Illinois Future: a worst-case example of what happens when a government no longer can pay its bills,” the Chicago Tribune wrote in an editorial.

Title III, created under the PROMESA legislation specifically to address Puerto Rico, may not provide a path for Illinois or other struggling states like New Jersey or Connecticut, but market participants agree it will weigh on investor minds, adding to worries over Illinois’ possible loss of investment grade status and concerns that default could lie ahead.

Those worries will likely translate into even higher interest rate penalties on future deals absent a budget solution, said numerous market participants.

“What makes this issue salient now is the trajectory of the state hasn’t improved and we are still going in the wrong direction,” said Brian Battle, director of trading at Performance Trust Capital Partners. “There is a parliamentary standoff that both sides are committed to.”

The notion that Illinois’ problems could be solved with a political compromise and tax increases hasn’t yet moved Gov. Bruce Rauner, a Republican, or the General Assembly’s Democratic majorities to move beyond ongoing negotiations to a solution.

The distance between the commonwealth and Illinois’ trajectories remains wide. The island filed for Title III with more than $70 billion of debt and about $50 billion of pension obligations. Illinois’ net tax-supported debt per capita totaled $2,681 compared to Puerto Rico at $15,637, according to a 2015 report from Moody’s Investors Service.

When Congress established the oversight board and laid the path for Puerto Rico to file under PROMESA last year, the legislation only provided an avenue for a U.S. territory.

While PROMESA doesn’t provide a path for Illinois, watershed occurrences in the municipal market like the Puerto Rico filing help make the unthinkable thinkable, such as a state eventually landing in some form of bankruptcy, Battle said.

Examples include Detroit’s attempt to treat some of its general obligation debt as unsecured. Another such moment looms as rating agencies have warned that Illinois could become the first state to fall into junk territory if political leaders don’t soon solve the state’s fiscal crisis.

“The academic question is would Congress intervene if a state’s finances got so bad that they needed some type of reorganization,” Battle said. “The answer is yes.”

It’s natural for investors to look at how Congress structured PROMESA as a “one-off, highly customized” measure to address a territory’s fiscal woes and see how eventually something along those lines could be applied to Illinois, said Matt Fabian, partner at Municipal Market Analytics.

Fabian added that Illinois is far from the dire economic straits that drove Puerto Rico into bankruptcy. Illinois has a strong and diverse economy anchored by Chicago and its current budget shortfall is largely driven by the expiration of an income tax hike. Puerto Rico has been suffering from a prolonged recession, high unemployment, and a population exodus.

Illinois, while paying steep interest rate penalties, continues to enjoy market access while Puerto Rico has been shut out.

“In the end it’s not what I believe, it’s what investors believe,” Fabian said, citing how Detroit’s Chapter 9 filing sparked headlines over whether Chicago was next. “In the same way, Illinois is likely to be affected” by Puerto Rico’s filing in a way that will be felt in its borrowing costs, Fabian said.

The Puerto Rico petition did not spark much change in municipal market trading levels and Illinois spreads on its 10-year bonds remained at a 215 to 220 basis point spread to the Municipal Market Data AAA benchmark, multiple market participants said.

While any type of future bankruptcy-like proceeding seems a long way off, a downgrade to junk and the potential for default loom larger for the buyside and municipal analysts.

“At the end of the day, Puerto Rico is not a full sovereign credit like any of the 50 states. Indeed, its territorial status is the very reason the island got its own unique ‘bankruptcy-like’ process, Title III,” Triet Nguyen, head of public finance credit at NewOak Fundamental Credit, wrote in the firm’s MuniCredit Insights published Friday.

“Illinois’ most immediate risk is a potential downgrade to below investment grade, not bankruptcy. The state still has a lot of options in terms of its revenue base, assuming the political leadership has the will, which at this point may not happen until next year’s gubernatorial election,” Nguyen wrote.

Gurtin Municipal Bond Management, which sees any attempt to push state bankruptcy as facing an “arduous” legal journey that would be fought by healthy states fearful over the penalty they could see as a result, thinks the filing’s impact on Illinois will be minimal.

“The chatter regarding Illinois certainly cannot help perception amongst investors, but its impact on the state’s borrowing costs is likely marginal when compared to the damage the state has already inflicted upon itself through its inaction in recent years,” said Tom Schuette, co-head of investment research and strategy. “The chatter is also probably minimal when compared with the potential fallout should the state have its ratings downgraded to junk which seems like an increasingly realistic scenario.”

A fall to junk would accelerate worries over default. Illinois has $26 billion of general obligation debt that enjoys strong statutory protections giving it priority status over most state spending. As social service providers and higher education institutions remain starved for payments, analysts and investors have warned that those protections are being tested.

Default jitters rise as “cushions of protection are thinned” by mounting bills and cuts in essential services that can cause a “political backlash,” said Richard Ciccarone, president of Merritt Research Services. “That can disturb the ironclad protection for a GO credit and at that point, no one, not creditors, not the public, not politicians, or taxpayers should take for granted that the state will solve its problems so that debts can be paid on time.

“The fact is if you let your liabilities become large enough and if you are not addressing the issue then you could face default or bankruptcy. Bad things can happen when you let things get out of hand for too long,” Ciccarone said.

While stressing Illinois is not there yet, he added that Puerto Rico’s filing stokes the fear factor for investors. “When fears are reinforced it has an adverse effect on borrowing rates,” he said.

Illinois lawmakers resumed their spring session Tuesday with efforts being revived to reach a bipartisan Senate budget fix that would include tax hikes, pension reforms, spending cuts and other reforms. If an agreement is reached, its fate in the House remains uncertain.

The state is rated at the Baa2/BBB level, two notches away from junk. One rating drop would leave its appropriation backed and moral obligation debt at a speculative grade.

--Paul Burton contributed to this article.

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