MuniLand– Illinois Budget Impasse Leads to Credit Downgrades

Just two weeks ago we commented on the Illinois budget impasses. This past week Fitch and Moody’s rating agencies downgraded Illinois State G.O. debt to BBB+ with a negative outlook due to the weakening state financial position and due to the ongoing budget negotiation. For an example of its damaging effects, the budget impasse is delaying pension payments to the State Employees’ Retirement System (ERS). In turn, the delayed payments have forced the ERS to ask the IL State Board of Investment to liquidate $100MM in assets by November 10 and another $125MM by December 10 to pay retirees’ benefits. The retirement system needs the additional liquidity because it does not have sufficient cash on hand to pay monthly retiree benefits. If Illinois could pass a budget with planned pension expenditures to the ERS, it would limit the need to sell investments. Moreover, the liquidation only exacerbates poor pension funding ratios. The market is pricing ten-year Illinois debt more like high yield debt. Bloomberg BVAL pricing indicates ten-year Illinois debt yields are approximately 3.93%, whereas the BBB BVAL curve is only 3.11%. This is an important observation because the market is telling us that Illinois GO debt is more risky than its credit rating would indicate and further downgrades could be in the State’s future. 

Sources: Bloomberg BVAL data, Bond Buyer and SNWAM Research