Illinois Governor JB Pritzker’s plan to use surpluses to pay bills and bolster reserves and pension contributions has drawn positive reviews from ratings agency analysts.
It remains unclear how quickly the fiscal measures, if passed, could trigger positive rating actions and whether they alone can earn improvements.
Pritzker’s proposals unveiled Wednesday that use sound tax collections to make headway on several of the state’s credit crunches have fellow Democratic lawmakers beating the drum for further improvements and some market players are seeing it happening.
“The reserve and pension action is small in scope, but positive and symbolic of the state’s fiscal improvement,” CreditSights said in a brief review of the Illinois budget proposal by analyst John Ceffalio. Principal of City Research, and Patrick Luby, Principal Market Strategist. . “The governor’s proposals are likely to be approved by credit rating agencies, leaving Illinois on course for positive rating news this calendar year as its credit slowly normalizes.”
Moody’s Investors Service and S&P Global Ratings raised the government’s rating one notch to Baa2/BBB in June and July, respectively. Fitch Ratings moved the negative outlook on the state’s BBB-minus rating to positive in July.
S&P went even further in November and upgraded the government’s outlook to positive. Illinois remains the lowest rated state and has a long way to go to catch up with the average ratings of states that fall into the double-A category.
Heading into fiscal 2023, higher-than-expected tax collections and billions in federal relief put the state in a better fiscal position than when it took a series of positive rating actions, but chronic retirement problems and questions about whether income in future years can keep pace with spending are weighing on the ratings.
That’s why rating agencies view the arrears action, rainy day fund and retirements so favorably. The state would funnel $879 million into a nearly empty rainy day fund, pay off nearly $1.3 billion in health insurance and other outstanding bills, and top up statutory pension contributions by $500 million. certified $9.6 billion from the state.
The budget also provides $1 billion in targeted, one-time tax relief through an income tax credit for homeowners, a sales tax exemption on groceries and the postponement of a fuel tax increase.
“To the credit of the state, they unwound many of the ad hoc fiscal maneuvers implemented before and during the early months of the pandemic, and also continued to make progress in repaying backlog bills to much higher levels. sustainable,” said Eric Kim. , Fitch’s principal Illinois analyst. “Some of the executive budget proposals clearly target the state’s biggest credit problems.”
The proposed action would be funded by excess revenue expected after the state raised estimates by about 5% to a combined total of $4 billion in the current and next fiscal year. The governor has proposed a general fund of $45.8 billion.
Analysts praised but warned that Pritzker’s proposals are far from final and that their eyes also remain on the state’s long-term trajectory, a signal that the state faces hurdles to raise the rating scale to a level in line with other states, unless it does more to meet its hefty $139.9 billion retirement bill.
The budget proposals also drew praise for relying on conservative growth estimates going forward and for limiting tax relief so as not to aggravate the state’s structural problems. “The temporary nature of the proposed tax relief is an attractive approach and may reflect caution in making significant tax policy changes amid some economic uncertainty,” Kim said.
“It’s a budget based on reasonable assumptions that addresses some of the credit risks that we’ve been discussing, so to that end it’s a budget that takes steps in a positive direction,” said senior analyst Geoffrey Buswick. of Illinois at S&P. The positive outlook assigned by S&P last November reflects a one-in-three chance of an upgrade over a two-year period.
S&P is first monitoring the contents of the final approved budget package – expected as early as April – and Buswick warned that passing a solid plan alone may not trigger rating action.
“In general, any additional money that goes into reserves or pays off long-term debt from excess income, we view that positively,” said Matthew Butler, Moody’s senior analyst for Illinois. “We are mindful that Illinois still faces more long-term liabilities and cost pressures than other states, but given the current revenue performance, the state is in a position to take additional positive measures.”
Investing more in paying pensions has received praise and the pension tab fell last year due to double-digit returns on investments mitigating the risk of increased short-term funding, but the burden remains onerous. Reductions cannot be made due to constitutional restrictions and contributions are tied to a statutory formula which does not match actuarial levels.
“The long-term challenges are still there and that burden will be carried by Illinois for some time to come,” Butler said.
Moody’s June update listed the enactment of recurring fiscal measures that support a sustainable fiscal balance, decisive actions to improve the funding of major state pension schemes, improvements to the state’s governance profile , such as constitutional or legal changes, as factors which individually or collectively could lead to an upgrade.
While the administration called the budget balanced, it is on a cash basis, and analysts said further review was needed before assessing the structure of the budget.
“The structural imbalance is built in” into the pension funding formula, so a gap remains as long as contributions are below an actuarial contribution, Buswick said.
State budget officials said the additional contribution would bring the state closer to a threshold of stability. Across all funds, the state owes the funds $10.78 billion, which is $4.1 billion less than an actuarially determined contribution.
A market participant also warned that the proposals may not go so far with analysts on the buy side and rating agencies.
“Building up the fund for rainy days makes sense, but most would like to see the cushion grow even more,” said Tom Kozlik, head of municipal research and analysis at HilltopSecurities Inc. “There are still a very large backlog of unpaid bills – states with a balanced budget do not find themselves in such a situation.
“The main story with Illinois remains its pension liabilities. Without meaningful structural reforms and a realistic, sustainable strategy to deal with them, the big question about Illinois remains – what does the fiscal balance look like? Illinois when federal relief runs out?” Kozlik asked.
Analysts also offered specific praise for the Pritkzer administration’s budget process which is seen as a positive credit item, but they expect the state to maintain a track record on this front.
“The relatively straightforward budget processes of the past few years have been another big improvement in credit and we’ll look to see if this return to more normal budget decision-making can be sustained,” Kim said.
Buswick noted that the move to a positive outlook also reflected the ratings agency’s view of the state’s “continued improved transparency,” which includes both its communications with the budget office and the metrics. enhanced data from Comptroller Susana Mendoza on her website, which reports on the status of bill payments and other financial data, including pension funding and the rainy day fund.
With funding for schools and higher education on the rise and local government revenue sharing remaining stable, analysts said they saw no challenges for governments downstream from the budget.
Only a few states are rated outside 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 state rated by S&P in the BBB to BBB-plus category with a positive outlook. Moody’s rates New Jersey A3 and Fitch has it at A-minus with a positive outlook.
Ahead of the June upgrade, Moody’s last upgraded Illinois’ rating in 2010, a move two notches to Aa3 prompted by a broad recalibration of municipal bond ratings.
S&P’s upgrade last July marked the first upward momentum in the rating agency’s rating in 24 years.
Rating improvements are reflected in the market, although spreads have widened this year due to tougher overall market conditions.
Spreads fell on Illinois’ competitive $400 million general bond issue in late November to 54 basis points on a 10-year maturity. The spreads marked the state’s lowest yield penalties in a decade and were down from a 115 basis point spread in the state’s March primary exit and a 268 basis point spread basic in an October 2020 show.
In the secondary, the state’s 10-year was 63 basis points higher than Municipal Market Data’s AAA benchmark at the start of the year. It widened to 68 basis points at the end of January and was fixed this week at a spread of 71 basis points.