Illinois Bondholders May Be In Danger Of Losing Big Money On Their Bonds Says Sonn Law Group

Law360, Springfield (May 11, 2017, 8:56 PM EDT) — With 15 more days scheduled on the Illinois General Assembly’s spring legislative calendar, state lawmakers received a pair of dire warnings this week that Illinois’ credit ratings were likely to tank into junk bond territory if no budget agreement is in place by spring session adjournment on May 31.

Testifying before a House committee Thursday, John Miller of Chicago-based municipal bond investment manager Nuveen Asset Management told lawmakers that the state’s 22 months without a budget has resulted in an extra $930 million in annual debt service payments statewide, due to higher interest rates assigned to progressively riskier bonds.

Miller said the three major credit ratings agencies — Moody’s Investor Services, Standard and Poor’s and Fitch Ratings — have all downgraded Illinois’ bonds six times in the past two years and have warned of further downgrades if May 31 comes and goes without some sort of budget deal in place.

“At this stage without a structurally balanced budget for fiscal year 2018, an attempt to borrow to pay down the backlog of bills I think would be another catalyst for another downgrade trigger,” Miller said.

The state faces a $13 billion backlog of bills, most of which have piled up since the budget impasse began between Republican Gov. Bruce Rauner and longtime Illinois House Speaker Michael Madigan, D-Chicago, began in 2015. Also at that time, a temporary income tax increase expired, leaving the state with less revenue to cover required state payments like pensions, Medicaid and interest on loans, along with state services paid via court order or put on autopilot.

A package of bills meant to kick-start compromise before Illinois enters a politically difficult gubernatorial election season, which is stalled in the Senate, includes legislation that would authorize the state to sell $7 billion of seven-year bonds to chip away at the backlog. But Miller told lawmakers that bonding is an expensive and short-sighted move.

“The backlog of bills itself should be thought of as a representation of a temporary political impasse,” Miller said. “But bonding it makes it more quasi-permanent. Ten-year bonds turns it into an almost 10-year problem. Thirty-year bonds — almost a permanent problem.”

Illinois’ general obligation bond credit rating is already the lowest in the nation at two notches above junk status. If the state reaches junk bond status, it cannot sell its bonds to pension funds, a major buyer of bonds worldwide. A report out Monday from Standard and Poor’s was not optimistic about the General Assembly’s prospects to pass a balanced budget before the end of session, strongly hinting that another credit downgrade is forthcoming.

“Negotiations on the grand bargain have stalled in recent weeks, raising the specter of Illinois beginning another fiscal year without an enacted budget,” Monday’s report said. “Absent an approved budget, the state’s backlog of unpaid bills has accumulated and weighs on our view of its credit quality. The backlog of bills and structural budget deficit also cloud the state’s longer term fiscal outlook. Already, state contributions to its pension system are scheduled to escalate rapidly in coming years.”

Last month, Standard and Poor’s downgraded five of the state’s public universities to junk status, while the bond rating of Illinois’ largest K-12 school district, Chicago Public Schools, has been at junk status since 2015. Moody’s last month warned that other public school districts around the state are in danger of downgrades, as their funding depends on the state writing checks, which the Office of the Comptroller has struggled to cope with in the state’s backlog of bills.

One bright spot from Thursday’s committee hearing: Illinois is better off than Puerto Rico, which last week officially declared bankruptcy on its $123 billion in debt. Miller assured House Revenue Committee chair Mike Zalewski, D-Riverside, that Illinois has more going for it, including a “substantially better economic base, larger population, much more diverse array of businesses, lower debt per capita … more stable economy.”

Puerto Rico declared bankruptcy with the consent of Congress as a territory, but Illinois as a state cannot declare bankruptcy outright.

–Editing by Brian Baresch.