S&P, Moody’s drop Illinois credit rating one notch above ‘junk’ status

Jun 01, 2017

Illinois credit rating now lowest on record for a U.S. state

Updated – June 1 at 4:30 p.m.

Less than a day after Republican Gov. Bruce Rauner and the Democratic-controlled General Assembly failed to reach a deal to end the two-year budget stalemate before the spring session deadline, both S&P Global Ratings and Moody’s Investors Service knocked down Illinois’ credit rating to just one notch above “junk” status.

The downgrade from BBB to BBB- not only remains the worst in the nation, it’s also the lowest grade S&P has ever given to a U.S. state, according to Bloomberg.

Not long after S&P announced its downgrade, Moody’s followed suit and lowered the state’s credit rating from Baa2 to Baa3, affecting $31.5 billion in general obligation bonds and related debt.

And as Illinois enters what likely could be the third consecutive fiscal year without a budget, both rating agencies are warning the state that it could lose its investment-grade status come July 1 if legislators and the governor are unable to work out a budget agreement that addresses the structural deficit.

“The rating actions largely reflect the severe deterioration of Illinois’ fiscal condition, a byproduct of its stalemated budget negotiations, now approaching the start of a third fiscal year,” S&P credit analyst Gabriel Petek said in a press release. “We placed the ratings on CreditWatch with negative implications because, in our view, the unrelenting political brinkmanship now poses a threat to the timely payment of the state’s core priority payments.”

Now that the spring legislative deadline has passed, however, it will become significantly more difficult to pass a budget as a three-fifths supermajority vote rather than a simple majority vote now is required in both the House and Senate.

“As the regular legislative session elapsed, political barriers to progress appeared to harden, indicating both the severity of the state’s challenges and the political difficulty of advocating their solutions. Extending the impasse, and the state’s embedded operating deficit of at least $5 billion (or 15 percent of general fund revenue) would signal further pressure on the state’s credit position,” Moody’s said in a press release.  

“But the state’s credit could stabilize at the current level in the event of a political consensus that more closely aligns revenues and spending, without relying on unsustainable fiscal measures.”

Illinois Treasurer Michael Frerichs said in a statement the two downgrades show how critical it is to end the gridlock and pass a balanced budget.

“Two credit downgrades in 24 hours further underscores the need for a full, balanced budget,” he said. “My warnings were ignored and credit agencies have responded. We need a bipartisan budget now to end this crisis.”

S&P also announced Thursday it lowered ratings on the state’s appropriation debt issued by the Illinois Sports Facility Authority and Chicago-based Metropolitan Pier & Exposition Authority into junk territory, from BBB- to BB+. Moody’s junked MPEA’s bond rating as well, knocking it down one spot to Ba1.

“In our view, the ongoing budget impasse has increased the nonpayment risk associated with Illinois’ obligations that require a budget appropriation before they can be funded,” S&P said. “We now view these payment obligations as having speculative-grade characteristics.”

With S&P’s and Moody’s downgrades, Illinois now has had its debt rating dropped eight times by the three major credit rating agencies since January 2015.

More from S&P:

The ‘BBB-‘ GO rating reflects our view of the state’s:

  • Large and growing structural budget deficit now projected to top $7 billion (18% of expenditures) in fiscal 2018;
  • Unpaid bills that have mushroomed to the equivalent of more than one-third of annual general funds’ expenditures;
  • Elevated fixed costs and depleted budget reserves, the combination of which renders the state vulnerable to even more fiscal pressure when the economy enters a slowdown;
  • Exposure to stepped-up interest costs related to variable-rate debt and swap termination payments tied to rating triggers;
  • Distressed pension funding levels that will require substantial contribution increases in the coming years; and
  • Inability to deliver adequate and timely funding for various important public services and institutions as a consequence of dysfunctional budget politics.

Partially offsetting these weaknesses is our view of:

  • Well-established priority of payment for GO debt service established by
    statute;
  • Ability to adjust certain cash disbursements to stabilize cash flow and to access substantial amounts of cash reserves on deposit in other funds for debt service, if needed, and for operations if authorized by statute;
  • Deep and diverse economic base anchored by the Chicago metropolitan statistical area, though with a growth outlook that is expected to trail the nation’s through the next five years;
  • Above-average income levels; and
  • Substantial ability to adjust revenues, expenditures, and disbursements–albeit with a current lack of agreement on how to do so.

And from Moody’s:

Rating Outlook

  • The state’s negative outlook is consistent with its 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.

Factors that Could Lead to an Upgrade

  • Implementation of a realistic plan to provide long-term funding for pension obligations
  • Progress in reducing payment backlog and adoption of legal framework to prevent renewed build-up of unpaid bills
  • Enactment of recurring fiscal measures that support expectation of sustainable, structural balance

Factors that Could Lead to a Downgrade

  • Continued increases in unfunded pension liabilities and indications of unwillingness to allocate sufficient resources to retiree benefits
  • Persistent and growing structural imbalance that pressures liquidity and increases payment backlog or bonded debt burden
  • Court rulings that increase the volume of payment obligations that are legally prioritized
  • Difficulty managing impact of any other adverse negative events, such as an unexpected economic downturn or reduction of federal Medicaid funding
  • Failure to enact legislation providing for timely payment of subject-to-appropriation debt
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