* Background is here if you need it. Press release…

On p. 22 of its new Credit Outlook released today (attached), Moody’s notes last week an appellate court for the State of Illinois (rated Baa3/negative outlook) reversed a lower court’s dismissal of a case challenging approximately $14 billion in outstanding general obligation (GO) debt for non-capital needs. The ruling is credit negative for the state because it prolongs a legal challenge that, while unlikely to prevail, carries severe risk and limits the state’s financial options at a time when the coronavirus pandemic is weighing on revenue. A court-ordered debt service disruption would harm bondholders and other parties, as well as the state’s capital market access.

Nothing in the appellate court opinion signals support for the plaintiff’s stated goal of forcing the state to stop paying debt service on bonds still outstanding from a $10 billion pension issue in 2003 and a $6 billion payment backlog financing issue in 2017. The state’s debt also includes $13 billion of GO bonds for capital projects and another $1.2 billion of one-year GO notes issued under state law allowing borrowing for unexpected deficits. We still view an ultimate ruling in favor of the plaintiff as highly unlikely, in view of the state’s constitutional power to borrow for statutorily defined needs.

An appellate court ruling at this stage supporting the lower court (and dismissing the case) could have settled questions on the state’s ability to use statutorily authorized debt for pension or bill-payment purposes and potentially alleviated some of the investor concern that has driven up Illinois’ borrowing costs compared with other issuers. The state’s fiscal year 2021 (ending June 30, 2021) general fund budget includes the potential issuance of about $1.3 billion in additional backlog bonds, which could provide a cushion if budget pressures intensify in the fiscal year’s second half. The existence of litigation against the backlog bonds would likely keep the state from using this option even if voters in November defeat a proposal to allow the state to raise revenue by imposing a progressive income tax.

Moody’s declaration of “credit positive” or “credit negative” does not connote a rating or outlook change. It is indicative of the impact of a distinct event or development as one of many credit factors affecting the issuer.