S&P Downgrades Illinois Debt, Sees Risk of ‘Negative Credit Spiral’

This article was originally published by Barrons.com.

Credit Analyst Gabriel Petek notes that Illinois debt already has speculative-grade characteristics and gives the state until July 1 to pass a budget.

By Amey Stone June 1, 2017 12:23 p.m. ET

Illinois general obligation bonds are getting awfully close to junk bond status.

On Thursday, S&P Global Ratings lowered its rating on that debt to to triple-B-minus from triple-B. The rating is just one notch from junk bond status. Plus, S&P has the bonds on negative credit watch, which means it could lower its rating again soon — potentially as soon as July 1 when the state’s new fiscal year starts.

It is S&P’s third debt downgrade for Illinois in the past year. Gabriel Petek, S&P’s U.S. States analyst, writes:

The rating actions largely reflect the severe deterioration of Illinois’ fiscal condition, a byproduct of its stalemated budget negotiations, now approaching the start of a third fiscal year. We placed the ratings on CreditWatch with negative implications because, in our view, the unrelenting political brinkmanship now poses a threat to the timely payment of the state’s core priority payments.

As if that’s not bad enough, he adds:

We also believe that Illinois is now at risk of entering a negative credit spiral, where downgraded credit ratings would trigger contingent demands on state liquidity, further exacerbating its fiscal distress.

Patek sets something of a deadline for Illinois legislators to come up with a budget. He writes:

If lawmakers fail to reach agreement on a budget with provisions designed to reduce the state’s structural deficit, it’s likely we will again lower the ratings.

Illinois is by far the lowest rated state. It is the only state S&P puts in the triple-B tier. All other states are in A-rated tiers. Most are double-A rated.

The GO debt already has characteristics that would put it in junk debt status, he notes. He includes a long list of negatives, including:

  • Large and growing structural budget deficit now projected to top $7 billion (18% of expenditures) in fiscal 2018;
  • Unpaid bills that have mushroomed to the equivalent of more than one-third of annual general funds’ expenditures;
  • Elevated fixed costs and depleted budget reserves, the combination of which renders the state vulnerable to even more fiscal pressure when the economy enters a slowdown;
  • Exposure to stepped-up interest costs related to variable-rate debt and swap termination payments tied to rating triggers;
  • Distressed pension funding levels that will require substantial contribution increases in the coming years;
    and
  • Inability to deliver adequate and timely funding for various important public services and institutions as a consequence of dysfunctional budget politics.

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