Illinois veto session highlights transparency debate about unpaid bills

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CHICAGO – Illinois’ nearly $16 billion unpaid bill backlog is front and center at the state capitol as lawmakers weigh whether to impose tougher reporting rules on state agencies.

The debate comes as the municipal bond market digests a $4.5 billion bond issue to help pay off some of those unpaid bills.

Lawmakers returned Tuesday to Springfield for the first day of a two-week veto session and state Comptroller Susana Mendoza, whose office manages the state’s checkbook, is pushing hard for an override of Gov. Bruce Rauner’s veto of the Debt Transparency Act.

An override motion has been filed and the comptroller’s office said the first vote, which would take place in the House, is expected Wednesday.

Under House Bill 3649, all state agencies would have to report monthly instead of annually what liabilities they are holding, whether there are appropriations in place to fund payments, the funding source, and an estimate of late payment interest costs. The information would be posted on comptroller’s website.

Mendoza says the importance of the new rules extends beyond simply managing the backlog that swelled during the impasse that left Illinois without a budget for two years and gave it by far the lowest ratings of any state.

She argues the bill represents a step toward getting the state back on a stable path by improving planning for future liabilities, allowing legislators to make better policy decisions about how to tackle the backlog and its accruing interest penalties, while also improving transparency for the public and the market.

“It’s a reform that needs to happen so we can identify the extent of our financial problems,” Mendoza said in an interview. “I believe the markets are looking to see the steps Illinois is taking to move the state on to sounder fiscal footing and this is one that’s important to cash and debt management."

The Republican governor vetoed the measure in August, saying the bill “more closely resembles an attempt by the comptroller to micromanage executive agencies than an attempt to get the information most helpful to the monitoring of state government.”

He attacked the requirements as too cumbersome and time-consuming. The bill was introduced by Rep. Fred Crespo, D-Hoffman Estates and Sen. Andy Manar, D-Bunker Hill, and passed with some GOP votes.

“As comptroller, I’d like to set up a comprehensive debt and cash management plan but I can’t do that if I don’t have full visibility,” Mendoza said. “I don’t know how old those bills are, and what interest is accruing and at what percentage. I don’t even know which of those bills are legally appropriated. We need to know how bad it is. We have a pretty good estimate but I have limited visibility on what state agencies hold.”

The lack of visibility can cause big single-day jumps in the backlog posted on the comptroller’s website. The market has watched closely as the backlog ballooned, over fears that it could drive credit deterioration and concerns that the growing obligations could eventually interfere with the prioritization of debt service.

Under the state’s Prompt Payment Act, most bills that are more than 90 days old accrue interest at 1% per month, or 12% annually, while bills from healthcare providers accrue at 9% after 30 days under the Illinois Insurance Code. The comptroller’s office has estimated the state will pay $900 million in interest on the current bill backlog.

Mendoza, a Democrat who previously served in the elected post of Chicago city clerk, took office in December after besting Rauner’s hand-picked comptroller Leslie Geissler Munger in a special election called after incumbent Judy Baar Topinka died.

The two state constitutional officers have sparred frequently, with Mendoza attacking Rauner for holding up a budget by demanding policy and governance changes and Rauner questioning some of Mendoza's bill payment policies.

In a commentary published in the State Journal-Register, Munger, now a deputy to Rauner, defended the governor’s position.

“Our state agencies should always be striving toward sound fiscal management and maximum transparency. However, due to factors unaccounted for by this legislation — factors like lagging technology and differences in the input and calculation of the required information — the primary effect of this mandate will be to increase costs and divert limited funds and staff attention from their core functions of providing services to the citizens of Illinois,” she wrote.

The bill backlog has long played a prominent role in the state’s credit profile as it presents a glaring picture of the state’s structural imbalance between spending and revenue.

It hit a previous peak near $10 billion until an infusion of revenue from a 2011 temporary income tax hike, which eventually dropped the backlog to between $4 billion and $5 billion.

The $36 billion fiscal 2018 budget package enacted after lawmakers overrode Rauner’s vetoes authorized $6 billion in general obligation borrowing to pay down the backlog. The state sold $1.5 billion competitively last week paying an all-in borrowing rate of 3.5%. The state returns as soon as Wednesday with a negotiated deal for the remaining $4.5 billion.

While investors and rating agency analysts frown on what amounts to deficit borrowing, the interest rate relief is viewed positively.

“This will be a positive development that should help both the state’s vendors and reduce the state’s interest costs,” John Miller, co-head of fixed income at Nuveen Asset Management, wrote in a recent quarterly review of market developments.

But market participants also warn of the perils should the state allow the backlog to again build, which could again threaten the state’s weak investment grade ratings.

“Refinancing the state's bill backlog with long-term bonds entails some risk, in our view. If the bonding plan is not paired with additional fiscal adjustments, the state could be left with a higher tax-supported debt burden and--once again--an escalating backlog of unpaid bills,” S&P Global Ratings wrote in its report on the upcoming deal.

S&P rates the state BBB-minus with a stable outlook. Moody's Investors Service assigns a Baa3 rating and Fitch Ratings BBB. Moody’s and Fitch have negative outlooks.

The record bill backlog is watched closely by the market. Investors view favorably the state’s practice of making a roughly $225 million monthly deposit into a special account to cover future debt service. Debt service is among $1.85 billion in “core” priority payments made by the comptroller along with pension contributions, payroll, and general school aid.

When a federal judge in June suggested she was inclined to order the state to speed up payments on old and new Medicaid bills by hundreds of millions monthly, state spreads to the triple-A benchmark shot up by 50 to 75 basis points to more than 300 basis points.

Mendoza also had warned without passage of a budget with new revenue the state would fall short of meeting all core payments later in the summer. She sought to make clear in multiple statements and in a Facebook address “that at no time were debt service payments going to be chopped.”

Pension payments also remained a priority as Mendoza said as she sought to avoid taking any cash management actions that could contribute or trigger a downgrade.

Spreads have steadily tightened since the budget was enacted in July and the 12-year maturity in last week’s GO sale landed at a 166 basis point spread to Municipal Market Data’s top benchmark.

The comptroller’s office will receive the proceeds after the Nov. 8 closing, allowing her to leverage an additional $2.5 billion in federal dollars by paying down Medicaid bills. A portion will also go to bring the state up to date on employee health insurance obligations.

“This will allow us to knock out almost all” of the higher interest bills “and take some pressure off our day-to-day crisis,” Mendoza said. The backlog obligations are broken into 35.1% of state employee health, 23.6% Medicaid, and 41.3% all other.

Along with some internal fund transfers permitted by the budget package, the bond deals should bring the backlog down to $7 billion by the end of the fiscal 2018 on June 30. Mendoza has authority to allocate the proceeds to any unpaid vouchers incurred prior to July 1.

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