Illinois Down to Its Last Strike with Rating Agencies

The state of Illinois does not have much cushion left as an investment grade credit, as both Moody’s and S&P downgraded the state’s general obligation bonds one notch to Baa3 and BBB-, respectively, last week. Moody’s and S&P’s ratings are its lowest investment grade ratings, and the state will need to take evasive actions to maintain those ratings. As of Thursday, Fitch had not revised its BBB ratings on the state GO.

Illinois is the midst of this predicament as a result of the ongoing stalemate between its state legislature and governor. While most state GO’s are rated AA or better, Illinois’ BBB level ratings are a gloomy reminder of how far Illinois has fallen over the last two fiscal years. In that time, the state has been unable to reach a budget agreement and its unpaid bills are approaching $15 billion. Its pension liability, according to Moody’s, has increased by 25% over just this past fiscal year. Illinois’ fiscal morass may carry over into a third fiscal year, as the Illinois legislature adjourned last Wednesday without adopting a 2018 budget. While the 2018 fiscal year does not begin until July 1, May 31 was a key date, not only as it was the end of the regular legislative session, but after that date any tax increases (which will be needed for Illinois to realistically balanced its budget) must be passed with a 3/5 approval of the legislature instead of a majority vote.

In essence, Moody’s and S&P have given the state another warning to take action. Moody’s has assigned a negative outlook and S&P a negative credit watch, which typically signals that the issuer has 90 days to take action to maintain its rating. In Illinois’ case, however, S&P has said it expects to take action “around the start of (the) fiscal year.”  In other words, adopt a balanced budget before June 30 or face a downgrade to non-investment grade.

It appears Fitch is willing to sit on the sidelines for now, as it has focused more on the need for all parties involved to reach a consensus on the budget rather than on the May 31 deadline to increase taxes with a simple majority vote. Periodically, Fitch ratings analysts have mentioned that they do not like to have volatility in their ratings. In that context, it makes sense that they are not firing a one-notch downgrade warning shot like Moody’s and S&P right now, but we expect that Fitch would downgrade the state if it fails to adopt a budget by June 30. 

While the potential lowering of a state GO to a non-investment grade rating would be unprecedented in the post-depression era, the rating actions are more a reflection of concerns over the fiscal impact of the political stalemate than an expectation that Illinois is moving toward default or repudiation of debt. Illinois has underlying credit qualities that should provide for credit stability, but the longer the state waits to adopt a budget, the more difficult it will be to pay bills and address its growing liabilities.

Source:  Fitch, Moody’s, Standard & Poor’s, State of Illinois May 1, 2017 Rating Agency Presentation