Illinois eyes borrowing billions through Fed’s short-term lending program

Illinois' fiscal 2021 budget may rely on borrowing billions through the Federal Reserve’s short-term borrowing program if separate direct funding help from the federal government that Gov. J.B. Pritzker and other governors across the country are seeking to help make up for COVID-19 tax losses fails to quickly come to fruition.

The fiscal 2021 budget plan taking shape as Illinois lawmakers returned to the capital Wednesday is expected to include a debt authorization allowing the state to access the Fed’s Municipal Liquidity Facility for up to $4.5 billion. Legislative sources cautioned that the amount of borrowing and the overall budget plans are still fluid and have not been finalized. The state must close a $6 billion to $7 billion gap in the next fiscal year that begins July 1.

Pritzker said he remains hopeful that federal aid will eventually pass Congress and the state won’t have to turn to borrowing.

“We hope not” to fully use the proposed authorization “because there is a state and local funding bill that is working its way through the Congress,” Pritzker said when asked if the state would tap the full $4.5 billion amount during his daily briefing Wednesday on the state’s response to the pandemic.

The fiscal 2021 borrowing authorization is being viewed as a “potential bridge” should federal aid that compensates states and local governments for lost revenue fail to win congressional approval anytime soon. House Democrats approved such a plan Friday, but the Senate GOP leadership has rejected it leaving the timing and prospects for such aid up in the air. “It would be an access-as-needed approach and if you get federal aid in a couple months you wouldn’t need to access it,” said one legislative source.

The hope is that the federal government would eventually approve aid that would help to repay the debt. Some pressures would also ease if voters approve a constitutional amendment on the November ballot allowing the state to move to a graduated income tax from a flat one. It would generate more than $1 billion for fiscal 2021 under proposed rates that hike the tax for top earners.

“It’s reasonably clear to me that Republican governors and Republican senators need to support their states just as much as Democratic governors and Democratic senators do, and so I think we will see a state and local funding bill go through the Senate — can’t tell you exactly when so our hope is to not have to access that window that has been made available to states but we will if we need to,” Pritzker said.

As previously reported by The Bond Buyer, Pritzker’s administration on Friday said the state would submit a notice of interest to potentially tap the program to competitive sell its $1.2 billion of one-year certificates that are on the day-to-day calendar. Under the new program, the state has access to nearly $9.7 billion of MLF borrowing based on its applicable revenues.

Lawmakers, facing an end-of-May deadline to approve a budget for the fiscal year that begins July 1, returned to the capital for the first time in several months. The governor’s stay-at-home order has left all but nonessential business shuttered and bans large gatherings. Many businesses will be allowed to reopen next week.

The debt authorization requires a three-fifths majority of the Illinois Legislature. Pritzker is a Democrat and Democrats hold a three-fifths majority in both chambers.

Pritzker last month released revised revenue estimates that warned plummeting tax revenue would drive a $2.7 billion revenue hole in the budget this year and another $4.6 billion in fiscal 2021. The state is plugging this year’s gap with the $1.2 billion certificate issue, will dip into non-general funds and is holding the line on some spending that combined will cut the deficit to $255 million.

In addition to the $4.6 billion revenue blow expected in the next fiscal year, the state must repay the $1.2 billion and $400 million of investment fund rollovers, driving the deficit up to $6.2 billion. That figure further climbs to $7.4 billion if voters reject the constitutional amendment on November’s ballot to allow the state to move to a progressive income tax structure.

The state is operating on a $40.6 billion general fund this year and Pritzker proposed a $42 billion fiscal 2021 budget in February.

With a $7.3 billion bill backlog and poorly funded $137 billion pension tab and minimal funds in reserves, the state has limited options without cutting deeply into services or pushing its pains on to local governments. The state expects that much of its expenses related to the pandemic will be covered by its direct aid allocation in the Coronavirus Aid, Relief and Economic Security Act. Illinois expects to receive about $3.5 billion with another $1.4 billion in additional funds going to eligible local governments.

“It’s not inconsistent with what other states are doing” by using nonrecurring measures to cover the pandemic’s tax losses, said Matt Fabian, partner at Municipal Market Analytics. “Illinois wasn’t going to use recurring sources so it was probably going to be either deficit borrowing or something else like” skipping pension contributions or deferring expenses. “It's a better option among the bad choices they have.”

Illinois would benefit from laying out a plan to repay the borrowing in the absence of future federal dollars, Fabian said. “They should at least suggest how they will retire this debt whether it’s through higher taxes or spending cuts.”

The three rating agencies that rate Illinois’ debt recently moved their outlook to negative and Fitch Ratings also downgraded the rating. All have warned that the state faces setbacks in moving toward structural balance due to the pandemic and recession and that the state must show it has a plan to get back on path. The state is rated one rung above junk.

Municipal Liquidity Facility and Illinois
Under the $500 billion federal program’s pricing guidance the state could borrow at a rate about 4% based on a comparable maturity overnight index swap rate that will be used as the base and then a 380 basis point spread tied to its ratings level which are one rung above junk. The fee is 10 basis points. The MLF pricing has been established to serve as a backstop, "not as a first stop,” said Kent Hiteshew, a Fed official who is running the logistics of the program.

“The penalty is designed to make sure, as we said at the outset, that state and local governments have access to liquidity, but it’s not designed to replace market sources,” Hiteshew later said.

The current terms allow eligible borrowers to use the facility through the end of the year and for up to a 36-month term. The debt can be paid off without penalty. The Fed could change some terms as it’s already pushed out the deadline by several months.

Illinois began considering the MLF for its certificates sale last week after the Fed expanded the rules to allow it to participate in competitive bidding. The state moved the $1.2 billion sale to the day-to-day calendar earlier this month. The state’s bonds are trading at peak spread penalties of 400 basis points and 425 basis points to the one-year and 10-year Municipal Market Data AAA benchmarks, respectively. Spreads to other benchmarks are similar.

The state last week sold 25-year exempt bonds at peak spreads with the one-year maturity landingat a 4.875% yield for a 433 basis point spread to the AAA scale and the 10-year settled at 5.65%, a 452 basis point spread to AAA benchmarks.

The Fed program, which was announcedin April to calm the municipal market and help its recovery from a tumultuous March, initially there were more questions than answers on the process. While the program’s term sheet says it is designed to serve as a backstop for eligible issuers struggling with market access, it takes into consideration pricing. “Lending may be available, but at prices or on conditions that are inconsistent with a normal, well-functioning market,” the term sheet says.

Hiteshaw said on Monday the program is “open today” to states and local governments struggling with financial woes during the pandemic. The program covers counties of 500,000 or more and cities of 250,000 or more.