Fitch moves rating outlook for Illinois to positive

Fitch Ratings moved Illinois' outlook to positive from stable as the state preps an up to $2.5 billion new money and refunding general obligation sale next month.

Fitch stopped short of following Moody's Investors Service and S&P Global Ratings in lifting the rating into the single-A category in its first review this year but signaled that if the state remains on track with current practices an upgrade could be in the offing. Fitch affirmed its BBB-plus GO rating and A sales tax-backed Build Illinois rating.

"The outlook revision to positive from stable reflects Illinois' strong commitment to making material improvements in its fiscal resilience with significant planned contributions to its formal reserve fund over the next several months," wrote Fitch's lead Illinois analyst, Eric Kim. "Execution on these commitments, combined with maintenance of recent progress towards structural balance through an uncertain near-term economic outlook, would support an upgrade."

Illinois remains the lowest rated state with BBB-plus, A3 and A-minus ratings from Fitch, Moody's, and S&P, respectively, but several rounds of upgrades over the last two years have moved it away from the brink of junk at BBB-minus where it landed in 2017 amid the two-year budget impasse. 

Fitch said its current BBB-plus rating "reflects operating performance that is adequate but well below other states, with a long record of structural imbalance primarily related to pension underfunding and recent incremental steps toward more sustainable budgeting practices," Fitch said.

S&P in February raised the state's rating and Moody's followed earlier this month. The actions rewarded the state for building up reserves and paying down debts with surplus tax revenues.

S&P affirmed its A-minus GO rating Thursday.

"The rating reflects our view that the recent trend of improvement in the state's financial flexibility, transparency, liquidity, and reserve position is expected to continue in the fiscal 2024 budget cycle and beyond," said analyst Geoff Buswick.

Moody's affirmed its rating in a report on the deal published Thursday.

The state tentatively plans to sell this spring $1.35 billion of new money in three tranches: $200 million in an A series to fund ongoing pension buyouts, $1 billion of tax-exempt B series for capital, and $150 million in a C series for capital. The state is also eyeing a refunding of up to $1.1 billion in a D series.

Wells Fargo Securities, Goldman Sachs, and Loop Capital Markets LLC will be joint senior managers.

"Material improvements in fiscal resilience, primarily through building reserves to, or approaching, $2 billion while maintaining recent improvements in fiscal management" as well as "sustained progress toward structural balance and improved liability management, primarily through materially narrowing the wide gap between actual and actuarially determined pension contributions" could drive an upgrade, Fitch said.

Pritzker's proposed fiscal 2024 budget would make some additional modest progress on the reserve and pension fronts. The budget anticipates falling revenue but the legislature's Commission on Government Forecasting and Accountability recently raised state revenue projections for the current fiscal year, putting more funding in play as a final budget is crafted this spring.

Fitch noted the state's decisions earlier this year to pump more funds into the rainy day account, pay off its federal unemployment trust loan were followed by the unveiling of a budget that "maintains the fiscal momentum with a supplemental pension contribution of $200 million, defeasance of $450 million in outstanding tobacco settlement bonds, and ongoing commitments to add to reserves.

"Collectively, the moves suggest the state's recent fiscal improvements are becoming increasingly embedded in its decision-making," Fitch said.

Fitch said while growth could slow due to a recession and the banking sector crisis adds to economic uncertainty as it could lead to a tightening of lending conditions, the state's uptick in current year revenues leaves a solid cushion to absorb potential declines.

"Structural gaps remain, primarily the underfunding of pension contributions," Fitch noted.

The 2024 budget funds the state's $10.9 billion statutory pension contribution but its falls $4.4 billion short of an actuarially determined contribution. The state made $500 supplemental contributions in fiscal 2022 and 2023 and plans a $200 million contribution in fiscal 2024.

This week, Comptroller Susana Mendoza reported making a $150 million deposit into the rainy day fund bringing it to $1.22 billion. Future transfers announced in January will push the fund to $2 billion by the close of the fiscal year June 30.

Mendoza is urging lawmakers to resist spending the latest uptick in revenues. "We must instead put as much as we can into the state's reserves to prepare for economic downturns," Mendoza, who backs pending legislation HB2515 that establishes automatic triggers for future deposits, said in a statement.

Secondary market trading spreads on Illinois GOs have narrowed along with the upgrades.

On Thursday, the state's 1/10/25 year maturities were set at a 60/125/145 basis point spread to the Municipal Market Data's AAA benchmark. That's five bp better on the short end and 10 narrower on the 10 and 25 year maturities than one week ago when they were at 65/135/155 bp, respectively.

Two weeks ago they were at 75/145/165 bp, and three weeks ago they were at 90/163/175 bps where they also opened the month at, according to Refinitiv-MMD.