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Regulation and Compliance > State Regulation

Illinois Cut Near Junk by S&P, Lowest Ever for a US State

By Elizabeth Campbell

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Illinois had its bond rating downgraded to one step above junk by S&P Global Ratings, the lowest grade that it’s given to a U.S. state on record, as a long-running political stalemate over a budget shows no signs of ending.

The company warned that Illinois is at risk of soon losing its investment-grade status, an unprecedented step for a state that would only deeper the government’s strain. Forgoing its usual 90-day review, S&P said Illinois will likely be downgraded around July 1, when the new fiscal year begins, if leaders haven’t agreed on a budget that starts addressing the state’s chronic deficits.

Illinois hasn’t had a full year budget in place for the past two years amid a clash between the Democrat-run legislature and Republican Governor Bruce Rauner. That’s left the fifth most-populous state with a record $14.5 billion of unpaid bills, ravaged entities like universities and social service providers that rely on state aid and undermined Illinois’s standing in the bond market, where investors have demanded higher premiums for the risk of owning its debt.

“The rating actions largely reflect the severe deterioration of Illinois’ fiscal condition, a byproduct of its stalemated budget negotiations,” S&P analyst Gabriel Petek said in a statement. “The unrelenting political brinkmanship now poses a threat to the timely payment of the state’s core priority payments.”

Illinois’s 10-year bonds yield 4.4 percent, 2.5 percentage points more than those on top-rated debt. That spread — a measure of the perceived risk — is the highest since at least January 2013 and more than any of the other 19 states tracked by Bloomberg.

The downgrade, which also dropped some debt backed by legislative appropriations into junk, came a day after Illinois’s legislature blew the deadline for approving a compromise budget by a simple majority. Now, it takes a higher threshold — three fifths majority vote in each legislative chamber — to pass anything. On Wednesday, Rauner, who is up for re-election in 2018, and Democratic House Speaker Michael Madigan, who controls much of the legislative agenda, faulted each other for the unprecedented gridlock.

The governor also held Democrats responsible for Thursday’s rating cut.

“Madigan’s majority owns this downgrade because they didn’t even attempt to pass a balanced budget, get our pension liability under control, and other changes that would put Illinois on better financial footing,” said Eleni Demertzis, a spokeswoman for Rauner. “The governor will continue working toward a truly balanced budget with changes to our system to grow jobs and provide real and lasting property tax relief.”

“Her comment is typical Rauner incompetence, and that’s too bad,” said Steve Brown, a spokesman for Madigan.

By June 30, the state will owe an estimated $800 million in interest and fees on the unpaid bills that have been piling up, according to estimates from Comptroller Susana Mendoza, a Democrat. She warned of “dire” consequences for residents if a budget isn’t reached by the start of fiscal year 2018 on July 1, including the shuttering of more social service providers and layoffs at public universities. With only a month to go before the start of fiscal year, the ratings cut wasn’t unexpected.

“We’re going to start to see some real pain now,” Senate President John Cullerton told reporters in Springfield on Wednesday. “We’re going to start to see downgrades. We don’t have any funding for schools. We don’t have any funding for higher end and a bunch of social programs. We don’t have a budget.”

Despite the lack of a budget, Illinois has continued to cover payments due on its bonds, and, like other states, has no ability to resort to bankruptcy to escape from its debts. A downgrade to junk, though, would add further financial pressure by increasing its borrowing costs and preventing many mutual funds from buying Illinois’s securities.

“It wouldn’t be too far of a stretch at this point” to get to junk,  Dennis Derby, a money manager in Menomonee Falls, Wisconsin, at Wells Fargo Asset Management, which holds Illinois bonds among its $40 billion of municipal debt, said in an interview before S&P’s downgrade. “I don’t know if being downgraded to junk would motivate the state to come together. You would think getting downgraded to a BBB would have motivated them and it didn’t.”

— Check out Don’t Mess Around With Government Pensions on ThinkAdvisor.

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