CHICAGO – As pressure built on Illinois lawmakers to break a historic budget impasse, the threat of a junk bond label took center stage.

Lawmakers on both sides of the aisle pointed to the threat that Illinois would become the first ever to fall into speculative territory during debate that led to a break in the gridlock and passage of a budget and tax hikes over Gov. Bruce Rauner’s vetoes.

Pressure built throughout the year, but the bond rating threat took a backseat to concerns about the fiscal hardships imposed on social services, public universities, capital projects and local governments by the impasse that left the state without a budget for more than two years.

It wasn’t until the regular legislative session ended May 31 and Moody’s Investors Service and S&P Global Ratings slapped the state with downgrades that left it on the verge of junk that the message hit home.

Moody’s left a negative outlook on the state but it was S&P that made clear a downgrade loomed without progress on shoring up its rocky finances by the July 1 start of the new fiscal year. Fitch Ratings too said July 1 was a critical juncture for action, but it rates Illinois one notch higher at BBB.

“I think from an optics point of view it was very powerful,” Howard Cure, director of municipal research at Evercore Wealth Management LLC, said of the “embarrassment” lawmakers felt of possibly becoming the first state to fall to junk. The secondary bond market was already trading the state’s general obligation paper at junk levels.

On issuing such warnings, rating agencies have to tread cautiously -- balancing the need to avoid advice on policy decisions while also being "explicit" with their concerns. "It's a fine line," Cure said.

Cure said a real turning point might have been a federal court’s order requiring the state to start paying nearly $600 million monthly in Medicaid vouchers that gave lawmakers the final push as it became clear the state government's $15 billion backlog of unpaid bills was at a breaking point.

Fitch and S&P offered Initial positive comments about the budget and have not commented since lawmakers overrode Rauner's vetoes to enact the budget.

Moody’s, on the other hand, threw cold water on the idea that passing a budget would stave off junk status. Moody’s put the state on review for a downgrade Wednesday even as final action on an override loomed in the House Thursday.

The review process will “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.

Howard Cure, director of municipal research at Evercore
“I think from an optics point of view it was very powerful,” Howard Cure, director of municipal research at Evercore Wealth Management LLC, said of the downgrade threats. Bloomberg News

There’s been no break in the partisan divide.

On Monday, state Treasurer Michael Frerichs, an elected Democrat, called on Rauner, a Republican, to meet with the rating agencies and “convince them that he embraces the decision of the Legislature and will implement the budget package.”

The recommendation was one in a series the state’s chief investment officer laid out to avoid a downgrade. “I understand that Gov. Rauner disagrees with the elected members of the House and Senate," Frerichs wrote. "However, should he not take these necessary steps, he is inviting the credit-rating agencies to plunge Illinois into junk bond status, the results of which will lead to higher property taxes,” he said.

Frerichs also called on Rauner to take steps to implement the $6 billion of bonding authority in the budget to pay down bills, sign a pending school funding overhaul to ensure schools open on time, and tone down his divisive rhetoric.

The Rauner administration dug in.

“The low rating from the rating agencies is reflective of the fact that Madigan's 32% permanent tax increase will not solve the problems created by decades of unbalanced budgets, unfunded pension liabilities, borrowing and high debt,” said Rauner spokeswoman Eleni Demertzis, referring to House Speaker Michael Madigan. “The best thing we can do is to work collaboratively to pass truly balanced budgets that pay down our debt, reform our pension system, and make the changes necessary to drive economic growth in our state.”


Moody’s rationale in putting the state under review stems from its “failure to achieve broad political consensus on how to move toward balanced financial operations.”

The plan appears to lack “concrete measures that will materially improve” Illinois ability to address a $126.5 billion pension tab or tackle its liquidity woes in a way that prevents a future buildup of the bill backlog.

Passage of $5 billion in tax increases will benefit the state’s ability to pay expenses and “is a positive,” but the review is looking at whether “that change in and of itself can limit what we see as the continued deterioration in the state’s credit standing," Moody’s lead Illinois analyst Ted Hampton said in an interview late last week.

“Here you appear to have a package of bills that the governor opposes but nevertheless he will be responsible for implementing them as the chief executive of the state,” Hampton said. “That absolutely points to the implementation risks.”

While the size of the backlog and how the state comptroller manages payment priorities amid the state’s severe liquidity crisis is a concern, Moody’s is more concerned about the future structural management of the backlog.

The size of the state’s debt burden is not a significant negative weight on the credit profile so borrowing could “make sense” as it would trade a 9% to 12% interest rate on the backlogged bills for one under 5%. Hampton said analysts might view the borrowing as having a “neutral” impact.

“It’s a negative for the state if they substantially increase the debt burden to pay down bills and turn around and build up the bills,” Hampton said. “What is the framework to ensure that the state won’t go forward and accumulate late bills again? I haven’t seen any provisions that clearly indicate a legal framework that will keep the state from relapsing.”

The package includes a series of pension changes proposed by Rauner that are estimated to shave $1.5 billion of contributions but would have little impact on the unfunded liabilities.

“We’ve seen a lot of reforms….for reducing the annual budgetary commitment” but they don’t necessarily “give the state a lot of benefit” in tackling the unfunded tab, Hampton said.

Senate President John Cullerton has offered a consideration model that asks employees to choose a cut in their benefits in exchange for raises continuing to be counted toward pensionable salaries.

That was not included in budget legislation. It’s estimated to save $1 billion in contributions and would lower the unfunded liabilities if it survives a legal challenge.

“That could make a significant dent,” Hampton said, adding that even though it faces a legal test the rating agency is looking to the state to “consider those kinds of measures.” The rating review is expected to be completed in the coming weeks.

The Rauner pension proposals would shift pension costs for high salaried employees of schools district and universities to the local employer, phase in over five years changes in actuarial assumptions, and establish a tier 3 hybrid defined contribution/defined benefit plan for new university and school district employees.

The Senate passed both the Rauner proposals and the consideration model but the House tinkered with the combined package. The House version allowed employees to choose a status quo option which would offset any potential savings and included Rauner’s tier 3 plan. More negotiations on Cullerton's consideration model are expected this summer.

The budget package calls for trimming the unpaid bill backlog by $8 billion. It relies on an initial $3 billion issuance of general obligation bonds to be repaid over 12 years with initial debt service coming from a $360 million surplus. Another $1.2 billion would come by borrowing from non-general fund accounts that would be repaid over two years and sweeping another $1.8 billion from non-general fund accounts. Another $2 billion could be leveraged in federal Medicaid reimbursements.

The state has been hit with eight downgrades over the last 28 months, leaving it the lowest-rated state.


During the initial House debate that led to passage of the budget ahead of the July 4th holiday and then during Senate debate on the budget and its veto override on July 4, the need to avert junk status emerged as a common theme.

“We formally move to override this veto motion to make sure that when the markets open tomorrow that we are not the first state in the history of the United States to reach junk status,” said Sen. Toi Hutchinson, D-Olympia Fields.

House GOP members who broke ranks defended their position. The House override, however, didn’t come until Thursday, a day after Moody’s review was announced, and it provided fodder for rank and file GOP members who stuck with Rauner.

Rep. Keith Wheeler, R-Oswego, said there’s been much talk of the “catastrophe” of a downgrade but it still looms given the Moody’s threat. “It’s time for us to get real and get to work,” he said.

“This budget is junk,” said Rep. Allen Skillicorn, R-East Dundee.

Other GOP members warned that without the override, downgrades were all but certain from several rating agencies while enactment of a budget would buy some time.

Voting against the override would result in a “financial meltdown” with a fall to junk certain, said Rep. Steven Andersson, R-Geneva. “This impasse has impacted our bond rating like nothing before…we need to work together to get this done.”

Rep. David Harris, R-Arlington Heights, said without action “we are looking the abyss, the financial abyss” and “if we don’t have a budget with virtual certainty we go to junk status.”

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.