Risks seen in Illinois' red ink and possible pension borrowing
CHICAGO — Illinois’ lowest-in-the-nation bond ratings hang in the balance as Gov.-elect J.B. Pritzker and lawmakers face decisions in the coming year over how to tackle red ink without piling on to a now $6.7 billion bill backlog while paying for a new capital bill and addressing the state’s $129 billion pension mess.
“Illinois faces important fiscal policy choices in its upcoming legislative session that will go a long way toward determining the direction of its credit rating and outlook,” Fitch Ratings wrote in a special report this week.
The report dives into the state’s near- and long-term fiscal strains. Fitch rates the state’s general obligation bonds BBB, one notch above Moody’s Investors Service and S&P Global Ratings. It assigns a negative outlook.
“Moves toward structural budgetary balance would support stabilization of the rating outlook at the current rating,” Fitch said. “While less sustainable measures such as one-time spending shifts or a return to aggressive build-up of accounts payable could trigger a rating downgrade.”
Pritzker, a businessman and philanthropist, will become a first-time political office holder next month when he’s sworn in. The Democrat will enjoy supermajorities of at least 71 Democrats in the House and 36 in the Senate.
While deep divisions between the Democratic-controlled General Assembly and Bruce Rauner, a Republican who won took office in 2015, drove a more than two year budget impasse that dragged the state’s rating to the edge of junk, one-party control is no panacea, Fitch said.
"Decisions may be made more quickly but not necessarily more prudently," wrote Fitch analyst Eric Kim. “Proof of this took place between 2003 and 2014 when the state's credit quality deteriorated considerably even with two different Democratic governors and sizable Democratic majorities in the General Assembly.”
Fitch warns the state to tread cautiously on borrowing to address rising pension costs.
Pritzker offered little detail during the campaign on how he might try to solve the rising costs of the state’s pension tab except to say pensions are a promise that must be honored.
The contribution hits $9 billion next year and inches up to $15 billion by 2036 and nearly $20 billion in 2045 under the current 45-year funding schedule to reach a 90% funded ratio. The state’s five-fund system is currently at a 39.9% funded ratio.
During the campaign, Pritzker suggested he might consider a re-amortization of the state’s current funding schedule that would funnel more payments in the near-term to reduce long term costs. Such a plan could include borrowing to cover the upfront payments. He then backed away from it.
Since Election Day, Pritzker has said he is seriously looking at altering the funding schedule.
"A proposal to use pension obligation bond proceeds to finance near-term contribution increases as part of a re-amortization of the state's pension liability, even as the state lowers its already inadequate statutory funding target, would be a credit negative," said Kim.
Ralph Martire, who has pitched the idea as head of the Center for Tax and Budget Accountability, sits on Pritzker’s budget transition committee. The CTBA has proposed issuing POBs to partially fund stepped-up pension contributions for several years while re-amortizing the pension liability to target a lower funding ratio by 2045.
“Fitch has previously noted that issuance of POBs is generally neutral to negative for an issuer's credit quality,” analysts wrote. “However, the CTBA proposal to use proceeds for budget relief by offsetting an annual pension contribution is viewed by Fitch as deficit financing.”
An estimated $2 billion in the state’s fiscal 2019 $38.5 billion general fund comes from either one-time measures or from a source unlikely to be realized by the end of the fiscal year June 30.
That number includes $800 million of uncertain revenue gains and expenditure savings, $800 million of borrowing from surpluses in non-general fund accounts that must eventually be repaid from general funds, and $400 million owed to employees for raises based on experience following recent litigation.
The risky sources also include $400 million in savings from pending pension buyouts, $140 million in new out-of-state online sales taxes following the high court’s Wayfair decision, and $300 million from the sale of the state’s downtown Chicago building that's no longer expected this year.
The state has traditionally dealt with some red ink by allowing its bills to pile up. The backlog hit a record $16.7 billion last year before a $6 billion borrowing cut the size. “After a debt-supported pay-down last year, the bills backlog is at risk of climbing once again,” Fitch wrote.
The state has little wiggle room to add to the backlog burden without potentially damaging its credit or to deal with a loss of income due to a recession, Fitch warned.
Pritzker offered limited details about how he would raise new revenue during the campaign. What was said includes possibly expanding gambling, legalizing recreational marijuana, and shifting to a graduated income tax from the state’s current flat tax.
The income tax shift is a cornerstone of his plans.
“Doing so requires a state constitutional amendment, which requires legislative supermajorities of 60% in both chambers of the General Assembly to refer it to voters,” Fitch wrote.
The rate changes would have “implications for Illinois' revenue growth prospects, natural pace of spending growth relative to expected revenue growth, and the state's operating performance” but all remains unclear since proposed rates, a phase-in period, and net revenue estimates have not been discussed, Fitch said.
Pritzker has pledged to move quickly on a new capital bill as the state’s decade-old plan is expiring. Transit agencies, local governments, and universities are all clamoring for capital help and package will find bipartisan support.
“The governor-elect has yet to articulate a specific dollar amount for a new capital bill, and whether there would be accompanying revenue sources to provide dedicated funding,” Fitch wrote.
A graduated income tax and a capital funding bill are not likely to have immediate effects on credit, but they could influence the long-term rating trajectory, Fitch said.
On Tuesday, Pritzker named a 45-member infrastructure transition working group.
The committee is charged with focusing on surface, rail, water, broadband and community infrastructure improvements. The top leaders of local transit agencies, the Chicago Infrastructure Trust, and Amtrak will serve on the committee as well as congressional members, legislators, business, and labor.