CREDIT RATINGS— WHY THEY MATTER FOR ILLINOIS TAXPAYERS

Illinois’ credit ratings are important because they determine how much interest state taxpayers will pay on bonds issued for borrowing. — Comptroller Susana A. Mendoza

Almost 20 years later, the year 2000 remains memorable for some special events. The world survived the Y2K scare, the first crew to live on the International Space Station arrived in space, and George W. Bush was declared the winner of the presidential election following a close vote that led to a U.S. Supreme Court case.

What people may not remember is that 2000 was the last year Illinois’ General Obligation (GO) bonds received an upgrade from any of the three major credit ratings agencies.

In June 2000, Fitch Ratings bumped its rating for Illinois’ GO bonds to AA+, just one notch below the highest investment-grade rating. Less than 17 years later, following seven consecutive prior downgrades from the agency, including one downgrade action that dropped Illinois’ rating two notches, Fitch downgraded Illinois’ GO bond rating for an eighth time, from BBB+ to BBB, just two notches above speculative, or junk, grade.

Between 2003 and 2017, Illinois’ GO bond ratings from Fitch, S&P Global, and Moody’s Investors Service consistently declined. Among the three agencies, Illinois received 24 total downgrades: eight from Fitch, seven from S&P, and nine from Moody’s.

As of Sept. 1, 2019, Fitch rates Illinois’ GO bonds two notches above speculative grade, and S&P and Moody’s rate Illinois just one notch above speculative grade. These ratings are the lowest for Illinois’ GO bonds in the state’s 46-year history of bond ratings.

WHAT HAPPENED?

Several factors contributed to the state’s financial difficulties, including the recession and subsequent budget deficit that followed the Sept. 11, 2001, terrorist attacks, from which Illinois struggled to recover.

In addition, growing obligations to the state’s five public pension funds were worsened by actuarially insufficient contributions by the state and overly rosy pension investment returns. These factors and others resulted in the funds’ estimated unfunded liability increasing from $14.3 billion at the end of fiscal year 1999 to an estimated $133.7 billion at the end of fiscal year 2018.

A 736-day state budget impasse between July 2015 and July 2017 led to a lack of appropriation authority that matched state revenues to expenditures, resulting in overspending via court orders and consent decrees. It also helped cause a surge in the state’s backlog of unpaid bills from an estimated $5 billion to a staggering $16.7 billion. The toxic political environment and gridlock between former Republican Gov. Bruce Rauner and Democratic majorities in the General Assembly left dim the prospects for resolving the impasse and addressing inadequate revenues to match the state’s obligations.

The most recent downgrades came from S&P Global and Moody’s Investors Service on June 1, 2017, the day after the traditional May 31 end of the legislative session, but still a month before the new fiscal year would begin. Both agencies downgraded Illinois by one notch, leaving the state just one downgrade away from junk status.

In its downgrade rating action, Moody’s cited a “prolonged political impasse” and “legislative gridlock” and stated “fundamental credit challenges have intensified enough” to justify the downgrade even if a budget agreement were reached in the legislative overtime session.

S&P stated its “actions largely reflect severe deterioration of Illinois’ fiscal condition” and that “Illinois (is) now at risk of entering (a) negative credit spiral, where downgraded credit ratings would trigger contingent demands on state liquidity.”

WHY TAXPAYERS SHOULD CARE

Illinois’ credit ratings are important because they determine how much interest state taxpayers will pay on bonds issued for borrowing.

In general, the higher a state’s credit rating, the less interest it will pay to borrow money needed, for example, for improvements to roads, bridges, and other infrastructure needs. The lower the rating, the higher the interest costs to pay off those bonds. More taxpayer dollars for interest payments means fewer dollars for critical state services, such as breast cancer screenings, programs to assist senior citizens, police and fire services, and schools, colleges, and universities.

The Illinois Office of Comptroller, in coordination with the State Treasurer’s Office, has worked to save state interest costs by utilizing a tool approved by the General Assembly and the governor in 2018. Under Public Act 100–1107, the treasurer can invest a portion of the state’s investment portfolio into the state’s pending unpaid bills, many of which accrue interest at a rate of 12% a year.

In 2018, Illinois State Comptroller Susana Mendoza and State Treasurer Michael Frerichs invested $700 million at an interest rate of approximately 3.7%, saving the state at least $26 million in interest costs. Despite these efforts to save taxpayer dollars, the state will continue to pay more in interest costs on bonds if it has a near-junk credit rating.

PROSPECTS FOR AN UPGRADE

The three major ratings agencies have provided actions they believe will improve Illinois’ financial condition and warrant improvements to the its credit rating — and factors that could result in more downgrades.

In its June 2017 rating action, Moody’s stated factors that could lead to an upgrade included the “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,” and “enactment of recurring fiscal measures that support expectation of sustainable, structural balance.”

MOODY’S FURTHER STATED THAT ACTIONS THAT COULD LEAD TO AN UPGRADE INCLUDE:

• Adoption of a comprehensive plan to address pension liabilities
• Progress in lowering the state’s backlog of unpaid bills that does not rely on long-term borrowing
• Enactment of recurring financial measures that support sustainable balanced budgets

HOWEVER, FACTORS THAT COULD LEAD TO A DOWNGRADE, ACCORDING TO MOODY’S, INCLUDE:

• Renewed growth in the state’s payment backlog that reverses progress attributable to long-term debt issuance
• Reduction in pension contributions to provide fiscal relief
• Substantial assumption of debt or pension liabilities incurred by local governments

During the spring 2019 legislative session, the General Assembly and Gov. JB Pritzker approved a fiscal year 2020 budget and the first major capital infrastructure plan in 10 years. Despite the successes, Comptroller Mendoza urged the state to remain grounded, with a focus on paying down the state’s pending bills. In affirming its Baa3 rating in June 2019, Moody’s sounded similar caution. It pointed to Illinois’ strengths, such as its “diverse, large and comparatively wealthy economic base,” but also to negative factors, including unfunded pension liabilities and “mounting fixed costs.”

As pointed out by Moody’s in its rating action, Illinois’ law provides that GO bonds are backed by the full faith and credit of the state and provides an irrevocable and continuing appropriation for payment (30 ILCS 330/17).

Following approval of the fiscal year 2020 budget, Carol Spain of S&P Global stated, “the fiscal year 2020 budget signals near-term credit stability” and “the state will need further progress toward sustainable structural balance, paying down its bill backlog, and addressing its pension liabilities to maintain an investment-grade rating.” As reported by The Bond Buyer, Eric Kim of Fitch Ratings stated a downgrade could occur if the state does anything to exacerbate its imbalance.

On July 31, Fitch Ratings responded to the fiscal year 2020 budget with a revised outlook, from the negative outlook it assigned in July 2017 to stable. Fitch cited the nearly $1.5 billion in additional revenue realized by the state in April 2019, which led to the closing of the fiscal year 2019 budget gap and the enactment of an on-time and ”plausible and achievable” fiscal year 2020 budget, “leaving the state better positioned from a fiscal perspective.” The agency warned of a downgrade if “the state exacerbates its structural budget challenges through measures such as materially” increasing the bill backlog or “proposals to defer or similarly alter pension obligations.”

As for the constitutional amendment language adopted by the General Assembly in May calling for graduated income tax rates, which will be approved or rejected by Illinois voters in the November 2020 general election, Ted Hampton from Moody’s cited the potential for the change to be a positive for Illinois’ credit.

Graduated rates would give the state “increased revenue raising flexibility to tackle a growing pension burden,” but a “positive outcome” would be dependent on “substantial net new revenue, without material damage to the economy, and the new revenue be largely allocated to addressing the state’s retirement benefits liabilities on a recurring basis,” Hampton said, according to The (Springfield) State Journal-Register.

The Bond Buyer reported that Hampton also stated the rates could be “credit neutral” if any new revenues were not largely devoted to addressing the state’s pension issues. “Unless (pensions and fixed costs are) improved it would be hard for us to see the state with a higher rating.”