Moody’s and Standard & Poor’s both downgraded their ratings of Illinois state general obligation bonds by one notch last week to Baa2/BBB+, both with negative outlooks. While Fitch maintained its BBB+ ratings on the state’s GO debt, the ratings are now on Rating Watch Negative, which means a downgrade by Fitch is imminent absent any actions by the state to effectively address its structural budget imbalance. The ratings were updated as the state prepares to issue $550 million of GO debt this week.
Illinois is in the midst of an unprecedented budget stalemate. It has operated the entire 2016 fiscal year, which ends on June 30, without a budget, and the Illinois legislature is unlikely to adopt a budget in time for the start of the 2017 fiscal year on July 1. The downgrades reflect concern that the state lacks a fiscal plan to tackle its growing budget deficit and growing liabilities. Although Illinois has a large and diverse economy and its personal income per capita exceeds the U.S. average, it is the poster child for political dysfunction and poor fiscal management among the U.S. states. After cutting income tax rates in 2015, the state has failed to reach a consensus on replacing those lost revenues or cutting expenditures. Without a FY16 budget, the state is expected to carry over an operating deficit of $3.5 to $4 billion into the new fiscal year, and a backlog of over $9 billion of unpaid bills. Illinois also has a pension funding level that has declined to under 42%, and a limited ability to cut its pension liabilities due to recent state court opinions.
Ratings in the BBB category for a state with Illinois’ financial resources show the level of dysfunction within the leadership structure of the state. Illinois is now paying for that dysfunction as it markets its debt with outstanding 10-year year GO bonds currently trading at nearly 200 basis points over the AAA muni bond scale. For some investors, those credit spreads are not enough penalty for the state’s refusal to address its fiscal problems. BlackRock, which holds nearly $120 billion of muni debt in its portfolios, has called for muni investors to boycott Illinois by limiting its access to the market. Given that Illinois statutes authorize the state to continue to pay debt service on its GO and other state debt even without a budget, some investors will still be attracted to credit spreads significantly wider than those of other states provided by the Illinois GO bonds, despite the chronicled frustrations of some investors.
Source: Bloomberg News, Fitch Ratings, Moody’s Investor Service, S&P Global Ratings