Illinois Gov. J.B. Pritzker’s plan to use surpluses to pay down bills and bolster reserves and pension contributions drew positive reviews from rating agency analysts.
It remains unclear how soon the budgetary measures, if adopted, might trigger positive rating actions and whether they can win upgrades on their own.
Pritzker’s
“The reserve and pension action are modest in scope, but positive and symbolic of the state’s fiscal improvement,” CreditSights said in a brief review of the proposed Illinois budget authored by John Ceffalio, senior municipal research analyst, and Patrick Luby, senior market strategist. “The governor’s proposals are likely to meet with approval by credit rating agencies leaving Illinois poised for positive rating news this calendar year as its credit slowly normalizes.”
S&P went a step further in November and raised the state’s outlook to positive. Illinois remains the lowest-rated state and has a long way to catch up to the average state ratings that sit in the double-A category.
Heading toward fiscal 2023, rosier than expected tax collections and billions in federal relief put the state in a better fiscal position than when it nabbed a series of positive rating actions, but chronic pension woes and questions over whether revenues in future years can keep pace with spending weigh on the ratings.
That's why rating agencies view action on the backlog, rainy day fund and pensions so favorably. The state would funnel $879 million to a near-empty rainy day fund, pay down almost $1.3 billion of overdue health insurance and other bills, and supplement the state’s $9.6 billion certified statutory pension contribution by $500 million.
The budget also provides $1 billion in targeted, one-time tax relief through an income tax credit for property owners, a sales tax holiday on groceries, and holding off on a motor fuel tax hike.
“To the state’s credit, they’ve unwound many of the one-time budget maneuvers implemented before and during the early months of the pandemic, and have also continued progress in paying down the bills backlog to much more sustainable levels,” said Eric Kim, Fitch’s lead analyst on Illinois. “There are some proposals in the executive budget that clearly target the state’s biggest credit challenges.”
The proposed action would be funded with surplus revenue expected after the state raised estimates by about 5% to a combined $4 billion in the current and next fiscal year. The governor proposed $45.8 billion general fund.
Analysts offered praise but cautioned that Pritzker’s proposals are far from final and their eyes also remain on the state’s long-term trajectory, a signal that the state faces hurdles moving up the ratings scale to a level in line with other states unless it does more to deal with its burdensome $139.9 billion pension tab.
The budget proposals also drew praise for relying on conservative growth estimates going forward and limiting the tax relief so as not to add to the state’s structural woes. “The temporary nature of the proposed tax relief is an interesting approach and could reflect caution in making large tax policy changes in the midst of some economic uncertainty,” Kim said.
“It is a budget based on reasonable assumptions that is addressing some of the credit risks we’ve discussed so to that end it is a budget that is taking steps in a positive direction,” said Geoffrey Buswick, lead Illinois analyst at S&P. S&P’s positive outlook assigned last November reflects a one-in-three chance of an upgrade over a two-year time frame.
S&P first is watching for what’s in the final approved budget package — expected as soon as April — and Buswick cautioned that passage alone of a sound plan may not trigger rating action.
“In general, any additional money that goes to reserves or pays down long-term liabilities that are coming from excess revenues we view positively,” said Moody’s lead Illinois analyst Matthew Butler. “We are not losing sight that Illinois still faces more long-term liabilities and cost pressures than other states but given current revenue performance the state is able to take additional positive steps forward.”
Putting more toward the pension payment received praise and the pension tab dropped last year due to double-digit investment returns easing the risk of near-term funding increases, but the burden remains onerous. Cuts can’t be made due to constitutional restrictions and contributions are tied to a statutory formula that falls short of actuarial levels.
“The long-term challenges are still there and that burden will be carried by Illinois for some time,” Butler said.
Moody’s June upgrade listed enactment of recurring financial measures that support sustainable budget balance, decisive actions to improve funding of the state's main pension plans, improvements to the state's governance profile, such as constitutional or legal changes, as factors that individually or collectively could lead to an upgrade.
While the administration labeled the budget balanced, that’s on a cash basis, and analysts said a deeper review is needed before assessing where the budget stands structurally.
“The structural imbalance is embedded” in the pension funding formula so a gap remains as long as contributions fall short of an actuarial contribution, Buswick said.
State budget officials said the supplemental contribution would bring the state close to a tread-water mark. Across all funds, the
One market participant also cautioned that the proposals may only go so far with the buy side and rating agency analysts.
“Building up the rainy-day fund is sensible, but most would want to see the cushion increased even more,” said Tom Kozlik, head of municipal research and analytics at HilltopSecurities Inc. “There is still a very meaningful backlog of unpaid bills — states that are fiscally balanced do not find themselves in a situation such as this.”
“The primary story with Illinois remains its pension liability. Without meaningful structural reforms and a realistic and sustainable strategy to address these the big question about Illinois remains — what does Illinois fiscal balance look like when the federal relief dries up?” Kozlik asked.
Analysts also offered praise specific to the Pritkzer administration’s budget process that is viewed as a positive credit feature but they are looking for the state to maintain a track record on that front.
“The relatively straightforward budget processes over the past few years have been another important credit improvement and we will be looking to see if that return to more normal fiscal decision-making can be maintained,” Kim said.
Buswick noted the move to a positive outlook also took into account the rating agency’s view of the state’s “continued improved transparency” that includes both its communications with the budget office and Comptroller Susana Mendoza’s stepped-up measures on her website, which reports the status of bill payments and other financial data, including pension funding and the rainy day fund.
With funding for schools and higher education up and local government revenue sharing holding steady, analysts said they don’t see any challenges posed to downstream governments by the budget.
Only a few states are rated outside of the Aa category by Moody’s and only five states rated by S&P are not in the double-A category. New Jersey is the only other S&P rated state in the BBB category at BBB-plus with a positive outlook. Moody’s rates New Jersey A3 and Fitch has it at A-minus both with a positive outlook.
Before June’s upgrade, Moody’s last moved Illinois' rating upward in 2010, a two-notch action to Aa3 driven by a
S&P’s upgrade last July marked the first upward momentum of the rating by that rating agency in 24 years.
The rating improvements are reflected in the market, although spreads have widened this year due to rockier overall market conditions.
Spreads tumbled on Illinois' $400 million competitive general obligation issue in late November to 54 basis points on a 10-year maturity. The spreads marked the lowest state yield penalties in a decade and were down from a 115 bp spread in the state’s primary outing in March and a 268 bp spread in an October 2020 issue.
In the secondary, the state’s 10-year was at a 63 bp spread to the Municipal Market Data’s AAA benchmark at the start of the year. It widened to 68 bps by the end of January and was set this week at a 71 bp spread.
