The monetary problems plaguing the state of Illinois (not to mention its public pensions) have been widely documented here over the past few years, and today the rating agencies finally noticed, when in the span of a few hours, first S&P, then Moody's downgraded Illinois to BB+/Baa3, respectively, both just one notch above junk, the lowest rating ever given to a U.S. state, as both agencies cited a long-running political stalemate over a budget shows no signs of ending.
In the first downgrade, S&P warned that Illinois is at risk of soon losing its investment-grade status, an unprecedented step for a state that would only deeper the government’s strain. Bypassing its traditional 90-day review, S&P said 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.
In a statement, S&P analyst Gabriel Petek said that "The unrelenting political brinkmanship now poses a threat to the timely payment of the state’s core priority payments."
Petek's ire was prompted by Illinois' inability to pass a budget for the past two years amid a clash between the Democrat-run legislature and Republican Governor Bruce Rauner. 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, Bloomberg reported.
The S&P analyst added that "the rating actions largely reflect the severe deterioration of Illinois’ fiscal condition, a byproduct of its stalemated budget negotiations."
In a similar statement, Moody's said that "legislative gridlock has sidetracked efforts not only to address pension needs but also to achieve fiscal balance, allowing a backlog of bills to approach $15 billion, or about 40% of the state's operating budget. During the past year of fruitless negotiations and partisan wrangling, fundamental credit challenges have intensified enough to warrant a downgrade, regardless of whether a fiscal compromise is reached in an extended session."
The rating agency added that "the downgrade to Baa3 for Illinois' GO bonds is consistent with the state's intensifying pressure from pension liabilities; by our calculation, the state's unfunded pension liability for its five major plans in aggregate grew 25% in the year ended June 30, 2016, to $251 billion."
And like S&P, Moody's kept the state on negative outlook, citing the potential for additional credit weakening "because of a continuing political impasse that has left Illinois increasingly vulnerable to adverse revenue trends and severely underfunded retiree benefit plans."
The downgrades, which also pushed some debt backed by legislative appropriations into junk, came a day after Illinois’s legislature blew the deadline for approving a compromise budget by a simple majority. Now, it gets even more difficult as it will take a higher threshold, or three fifths majority vote in each legislative chamber, to pass anything which effectively guarantees that one month from today Illinois will be America's first ever Junk rated state.
On Wednesday, governor Rauner, who is up for re-election in 2018, and Democratic House Speaker Michael Madigan, who controls much of the legislative agenda, faulted each other for the unprecedented gridlock. The governor also held Democrats responsible for Thursday’s rating cut.
Cited by Bloomberg, a spokeswoman for Rauner said that “Madigan’s majority owns this downgrade because they didn’t even attempt to pass a balanced budget, get our pension liability under control, and other changes that would put Illinois on better financial footing. The governor will continue working toward a truly balanced budget with changes to our system to grow jobs and provide real and lasting property tax relief.”
“Her comment is typical Rauner incompetence, and that’s too bad,” said Steve Brown, a spokesman for Madigan.
Meanwhile, as the political circus continues, Illinois' unpaid bills are piling up.
By June 30, the state will owe an estimated $800 million in interest and fees on the unpaid bills that have been piling up, according to estimates from Comptroller Susana Mendoza, a Democrat. She warned of "dire" consequences for residents if a budget isn’t reached by the start of fiscal year 2018 on July 1, including the shuttering of more social service providers and layoffs at public universities. With only a month to go before the start of fiscal year, the ratings cut wasn’t unexpected.
“We’re going to start to see some real pain now,” Senate President John Cullerton told reporters in Springfield on Wednesday. “We’re going to start to see downgrades. We don’t have any funding for schools. We don’t have any funding for higher end and a bunch of social programs. We don’t have a budget.”
Just like Venezuela, despite not having a budget, Illinois has dutifully continued to cover payments due on its bonds, and, like other states, has no ability to resort to bankruptcy to escape from its debts.
For now. A downgrade to junk, though, would add even more financial pressure by increasing the state's borrowing costs and preventing many mutual funds from buying Illinois’s securities.
To be sure, today's announcement did not come as a surprise to markets: Illinois’s 10-year bonds already yield 4.4%, 2.5 percentage points more than those on top-rated debt. That spread is the highest since at least January 2013 and more than any of the other 19 states tracked by Bloomberg. In fact, ths spread to AAA debt is now the highest on record.
Discussing next steps, Dennis Derby, a money manager at Wells Fargo which holds Illinois bonds among its $40 billion of municipal debt said “It wouldn’t be too far of a stretch at this point” to get to junk, , said in an interview before S&P’s downgrade. “I don’t know if being downgraded to junk would motivate the state to come together. You would think getting downgraded to a BBB would have motivated them and it didn’t."