Illinois Bond Spreads Explode As Market Pukes On Latest Batch Of Bad News

Tyler Durden's picture

On June 1, first S&P the Moody's almost concurrently downgraded Illinois to the lowest non-Junk rating, BB+/Baa3 respectively, with both rating agencies warning that the ongoing legislative gridlock and budget crisis need to be resolved, or else Illinois will be the first ever US state downgraded to junk status.

S&P analyst Gabriel Petek explicitly warned that "the unrelenting political brinkmanship now poses a threat to the timely payment of the state’s core priority payments" and warned about Illinois' inability to pass a budget for the past two years amid a clash between the Democrat-run legislature and Republican Governor Bruce Rauner. As we have documented previously, the ongoing confrontation has left the fifth most-populous US state with a record $14.5 billion of unpaid bills, ravaged entities like universities and social service providers that rely on state aid and undermined Illinois’s standing in the bond market, where investors have demanded higher premiums for the risk of owning its debt.

Bypassing its traditional 90-day review, a terse S&P also warned that Illinois will likely be downgraded around July 1, when the new fiscal year begins if leaders haven’t agreed on a budget that starts addressing the state’s chronic deficits.

Unfortunately for Illinois, and its bondholders, the downgrade - and the subsequent imminent "junking" - was just the tip of the iceberg.

As Bank of America wrote in its latest muni market report, among the $14.7bn backlog of bills (as of 5 June) to be paid by the state of Illinois due to the protracted budget impasse is some $2bn-plus in Medicaid-related payments owed to the private insurers the state contracted with to manage roughly two-thirds of its Medicaid recipients. Those payments amount to some $300mn per month. A number of private insurers have sued in U.S. District Court for the Northern District of Illinois to prioritize their payments over those due to other vendors.

Then last Wednesday, following the Illinois downgrades, the court ruled against the state. The judge ordered the parties to "continue to negotiate to achieve substantial compliance with the consent decrees in these cases. If they cannot reach a negotiated solution, either party may make an appropriate motion, to be noticed for presentment on June 20, 2017."

The day before the court ruled, the state submitted a filing with the Court, arguing that should the court prioritize those payments - effectively making them on par with so-called "core payments" which include debt service - it could trigger another downgrade from the rating agencies. Indeed, included in Moody's downgrade report under the headline "Factors that could lead to a downgrade," Moody's points to "[c]ourt rulings that increase the volume of payment obligations that are legally prioritized."

The state asked the court in that filing that, if it were to rule against the state and prioritize those Medicaid payments, that it make its order effective 1 July, requesting so for two reasons:

  • It "likely will avoid an immediate downgrade and also would send a message to the Illinois General Assembly and Governor that they have until June 30 to resolve the State's budget impasse and avoid the consequences of the Court's order. If the budget impasse is not resolved by July 1, that fact alone likely will lead to a rating downgrade, regardless of the effective date of the Court's order."
  • It "will give Defendants some additional time to determine how to comply with the Court's order."

Additionally, the Illinois Comptroller warned against an adverse ruling, saying the state would "have to go to the courts and ask them: 'OK, out of all of these court-mandated payments, which ones am I allowed to violate?'"

With all that, the court still ruled against the state saying that the Court said it believes the Comptroller "faces an unenviable situation," though it finds "that minimally funding the obligations of the decrees while fully funding other obligations fails to comply not only with the consent decrees, but also with this court's previous order."

So for anyone confused, here is a summary of what happened: a judge ruled last Wednesday the state is violating consent decrees and previous orders, and instructed the state to achieve "substantial compliance with consent decrees in these case." The order may prioritize those payments, elevating them to the level of "core payments," such as for debt service. The state has warned that could trigger an immediate downgrade from Moody's. The state asked the court that the order become effective on 1 July as it could pressure the state to end its protracted budget impasse.

* * *

Separately, there was a glimmer of hope for the woefully underfunded state: according to the Illinois Commission on Government Forecasting and Accountability's (CGFA) May Monthly briefing, May net revenues of $2.19bn were up $144mn, or 7.0% compared to the same month a year ago. Personal income tax collections performed well during the month, bringing in $1.17bn, $179mn, or 18.1% more than in April 2016. Sales tax collections also performed well, outperforming April 2016's collections by $36mn, or 5.5%. However, the state's other significant revenue stream - the corporate income tax - underperformed, with collections of $81mn coming in $72mn, or 47.1% less than a year ago.

And while April marks the third consecutive month of Y/Y outperformance, a glimmer of sunshine in an otherwise dready Illinois monetary landscape, the recent burst in receipts is likely a fluke especially since fiscal year-to-date collections of $26.54bn are $955mn, or 4.3% behind last year. The culprit: local businesses, as corporate income tax collections have been the main cause under-performance, falling $909mn, or 41.3% on a year-over-year basis.

What happened next? As Bank of America writes, with bondholders still digesting the recent downgrades and the inevitable downgrade to junk, news of the adverse court ruling caused spreads on Illinois' GOs to blow out. As of last Thursday, the month-to-date spreads on Illinois widened by 69bps, surging just shy of 250 bps as the market absorbed the headlines. Then according to Bloomberg, the OAS on Illinois 5% GO due Mah 2015, soared nearly 40 bps since last Thursday.

The chart below shows how the spreads have moved wider each day since the month began. On Thursday the spread widened out by 28bps, compared to average 8.2bps it moved the previous five days. Since then the move has accelerated.

Finally, Reuters today reported that Illinois appears to have essentially thrown in the towel on getting junked,  and has negotiated lower credit rating termination triggers for its interest-rate swap deals with banks, "which stood to pocket fat fees if the state is downgraded to junk as soon as next month, a spokeswoman for the governor's office said on Monday. "

Eleni Demertzis, the governor's spokeswoman, said the rating levels that would trigger the termination of four swaps - two with Barclays Bank, and one each with Bank of America and JP Morgan - were dropped a notch to the second level of junk - BB with S&P or Ba2 with Moody's.

Without this step, downgrades to the first level of junk by S&P or Moody's Investors Service could have forced the cash-strapped state to pay the banks as much as $39 million in fees to end the swaps, according to the Illinois Comptroller's office.

In short, while Illinois won't be punished with higher swap termination costs when the downgrade to junk hits, all other negative side effects of being the first "fallen angel" state in history will remain, chief among them far higher borrowing costs.

* * *

And while the recent blow out in spreads has been nothing short of stunning for the otherwise sleepy muni market, a far bigger problem awaits both Illinois, which faces substantially higher borrowing costs, and bondholders, whose principal losses are starting to hurt, if the state fails to pass a budget for the third consecutive year and is downgraded to junk. A default is also not out of the question.

Traditionally, sharp moves in the bond market - such as thise one - have been sufficient to prompt politicians to reach a compromise, although in a world in which central banks have always stepped in to make things better, we fail to see how or why the Illinois auto pilot, which is currently set on collision course with insolvency, will change direction any time soon.

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SoDamnMad's picture

Is (was) Illinois going to build a presidential library for the former Kenyan in Chief?  If so, snatch that money to pay your Medicaid bills so that those who voted for him in his past terms in office  will get health coverage. He would certainly want that.

847328_3527's picture

"I fundamentally changed Illinois!"


~ Hussein Barrack bin Bama

Al Gophilia's picture

He fundamentally changed America. Nobelly.

JLee2027's picture

And he made the Democrats go extinct. That will be his legacy.

gatorengineer's picture

Sorry from my chair they have never been stronger..... the dem states have gone full retard.  I dont see them loosing much in the swing states either.  In hardcore red they are in trouble but thats it

Exalt's picture

Your statement is on the wrong side of the ideological pendulum swing. Dems have gone full retard and that's exactly why you are wrong.

oDumbo's picture

Now looky here, I am the OJ!

Chauncey Gardener's picture

So did Boss Twead. Learn history, before the revisionists purge this.

Secret Weapon's picture

"...or else Illinois will be the first ever US state downgraded to junk status."  Come on Land of Lincoln, you can do it. 

Bam_Man's picture

Meredith Whitney was right - only 8 years too early.

Gotta hand it to these guys - with their Goldman Sachs henchmen, they can hide total insolvency for far longer than we thought possible.

Boris Gudonov's picture

Tell me again which political party has run Illinois for the last 80 years according to the principle that everyone deserves everything they want as a right because rich people.

And of course Illinois will shortly be demanding a bailout from the rest of the country, because being a liberal means nothing is ever your own fault.


IENTJ's picture

The moon land is the solution ... roll all that into a securitized framework for financial buggery ... buys the pension funds another 3 or 4 years ... though it might spark a moon cult ...

rockstone's picture

Maybe not a moon cult but.......There might be a good dollar made selling Kool-Aid up there. The pensioners will go bat shit crazy and wont' be able to take it.

Then again.....that might save the plans! Those actuaries are geniuses!

IENTJ's picture

This "moon bond" thing has so many angles ... we can send the old folkd TO THE MOON ... like I'm Jackie Gleason ... We send the "retirees" to the moon, in shoddy rockets .... people will never know what happened to them ... on the moon.

DocBerg's picture

Actually, this problem goes back at least 60 years, and both wings of the Big Government Party have done their best to foment this disaster.  There actually isn't much difference between Lake and DuPage County liberal Republicans, and the Chicago Democratic Machine liberals.   None of them know much about the rest of the state, nor care about the economy in the rest of the state. 

And, since there are no longer any easy ways out of the impending insolvency, the state government is going to stay paralyzed. 

Flee while there is still time!  I sure wish I could...

oDumbo's picture

Ring...ring.  Hello, Connecticut?  Listen, is there any way we could borrow a few hundred billion from you, chill out, we're good for it.  What's that, you were just about to call me?

murpheus's picture

Our local DMV office in Lake County had to move to another town because their landlord kicked them out because they were 6 months behind in rent. Sell your house while you can.

Treason Season's picture

Oh and Jim Thompson is a paragon of moral rectitude.

IENTJ's picture


(too bad for them)

order66's picture

Meanwhile Putin throws another opponent in jail for 30 days for "organizing public meetings".

Great guy that Putin.

Bam_Man's picture

Oh yeah, he's a real bastid.

Winston Churchill's picture

You hang 5th columnists in wartime, the guy is lucky.

WWIII started sometime ago, right after Sochi,at least thats what the historians will say.

Whether they will be human or cockroach historians is open to conjecture.

Zorba's idea's picture

i wouldn't short the cockroaches

Zorba's idea's picture

i wouldn't short the cockroaches

opport.knocks's picture

He was jailed for moving his "protest" from the permitted location to the location of national Russia Day celebrations. Call me so I can laugh when Soros funded BLM crashes your local 4th of July parade (it will happen sooner than you think).

Scuba Steve's picture

good, maybe a few less firecrackers and a lot more lead from the BANG BANGS ...

squid's picture

Obama did that by means of the IRS with the tea party....

Or did you miss that?


Oh I know, it's America so it's ok because America is just so fucking exceptional.

A Thai get s a kickback and it's corruption, the Congress man get 50K for his re-election, that's fine.


Fucking exceptional indeed.



hairball48's picture

Fuck Illinois. The voters elected corrupt pols and allowed them to borrow the state into the bed of insolvency. let them lie in it.

totenkopf88's picture

The D pols get  the govt employee union votes which is a huge employer in IL

meditate_vigorously's picture

You can lose all sorts of licensing and permits as well as your job, if you vote the wrong way in Chicago. It is an open secret and elections in dictatorial countries are more legitimate.

Ghostdog's picture

As someone who lives in this cesspool of corruption I can tell you this Most people in Illlinois fucking hate this shit. Why this state stays blue is because of Chicago and East St Louis. Those are the only counties that vote blue. the rest of the state is red but that is wherre the mass voter fraud is for Madigan, Cullerton and the cocksucker Rahn. Send ISIS or Blackwater in to kill everyone in those countries and you have a very fiscally responsible state. ....

silvercity's picture

As someone who also lives in this cesspool(Madison Co) I percieve that most people do not care what is going on in Il. politics. Whatever happens in government collapse, most citizens of Il. will not be affected. Even thou the state administers welfare, most is funded by Federal dollars. People will still own(or not) houses and live in them. Businesses will continue and people will be employed and payed. The world will not end and most people will hardly notice. Bond holders and public pensioners will notice admist wailing and knashing of teeth.

Scuba Steve's picture

You must of not read the fine print about state taxes and property taxes being responsible for any shortage of funds, huh?


silvercity's picture

There is a limit as to what government can take and Illinois is very close to that limit. Thus the dire talk of bankruptcy.

NoPension's picture

Yeah, right. There's a limit.....hahaha! Those motherfuckers will bleed the hosts dry...and not blink or even give it a thought. As long as government employees and pensioners get theirs.....Fuuuuck youuuuu!

Lost in translation's picture

Same with CA.

Gay Bay, Sacramento, and Ciudad de Los Angeles overpower the rural and agricultural populations, and dominate the state.

Urban cesspools of pedos, sodomites, and illegals running the state right into the dirt.

The financial collapse of CA would a blessing of the best sort.

ZD1's picture

Commiefornia’s unfunded public pension systems CalPERS and CalSTRS are nearly $1 trillion in the hole – or $946.4 billion.

Under CalPERS, civil servants became eligible to retire at 55 — and in many cases collect more than half their highest salary for life. California Highway Patrol officers could retire at 50 and receive as much as 90% of their peak pay for as long as they live.  Commiefornia's Democrat Gov. Gray Davis signed the legislation 1999 after he received more than $5 million in campaign contributions from public employee unions.

CalPERS became an outright lobbyist for higher member benefits. CalPERS has also steered billions of dollars into Democrat connected firms. And it has ventured into “socially responsible” investment strategies, making bad bets that have lost hundreds of millions of dollars.




brown_hornet's picture

I live in east central DuPage, used to be solid repub.  Now every one of my state and fed reps are all D's

LittleGreenMan's picture

You mean Illinois did what the US has done?

NoPension's picture

Remind me again....why was Madoff locked up?

He's a rank ametuer compared to your average politician.

PGR88's picture

We should welcome bankruptcy.

Leftiists and social engineers have survived for 70 years on growing government and personal debt, courtesy of the Federal Reserve.  It has corrupted society in so many ways.

Dewey Cheatum and Howe's picture

we won't have to worry about the debt downgrade, just wait 'til all those state retirees figure out they'll be getting only $800 per month. then the shit will really fly apart. but...they'll bame the Rep Govneror.

booboo's picture

800 a month won't buy a box of Depends once The Troll and her compadres get done debasing.