* S&P Global Ratings…

Enactment of a fiscal 2018 budget in Illinois did not bring an end to the ongoing political stalemate that caused its two-year budget impasse. The governor and General Assembly remain at odds over funding policy for the state’s school districts. It is also uncertain, in S&P Global Ratings’ view, whether the governor will proceed to implement a budget provision authorizing the state to refinance a portion of its accumulated budgetary debt with general obligation (GO) bonds. Reducing the backlog of unpaid bills with lower-interest-cost GO debt would restore some of the state’s capacity to engage in extraordinary forms of cash management.

In our view, Illinois’ growing reliance on delaying payments was a sign of its intensifying fiscal stress. Its ability to do so, however, served a crucial reserve-like function during its protracted fiscal crisis. We don’t take a position on any of the state’s specific debt or fiscal policy proposals. But given that its budget reserve remains depleted, we believe that foregoing the opportunity to replenish some of this implicit cash flow borrowing capacity would leave the state’s liquidity profile subject to heightened vulnerability. The Illinois General Assembly recently approved a permanent increase in the state’s individual and corporate income tax rates, which should help bring its budget closer to balance. Throughout its unprecedented two-year budget standoff, however, Illinois’ revenue base was structurally inadequate to support its authorized and legally required payment obligations. In response, the state comptroller prioritized paying the state’s core commitments over those she deemed to be lower-priority claims. In our view, the state’s practice of delaying payment on some of its obligations represents an exercise of its sovereign authority and is a tool that enabled it to sustain the funding of essential services. In the context of the state’s budget crisis, the payment deferrals insulated Illinois’ ability to cash-fund in a timely manner what the comptroller determined are the state’s core obligations, including debt service. But given its widening structural deficit in fiscal years 2016 and 2017, the bill backlog soared to record levels and by the end of fiscal 2017 was approaching $15 billion.

We believe there is a threshold beyond which the state’s ability to triage its cash and various payment obligations in favor of its chosen priorities can become impaired. Given its status as a sovereign, the precise boundary of this limitation for Illinois is unspecified. However, a recent federal court ruling circumscribed the state’s leeway to continue delaying payments to its Medicaid managed care organizations (MCOs). The ruling found that the state was not compliant with prior consent decrees pertaining to the timeliness of payments to the MCOs. We viewed this as a sign that Illinois was rapidly approaching the point at which even its emergency cash management measures would become exhausted. Because of the court’s ruling, beginning in July the state was required to increase payments to the MCOs by $290 million per month (net of federal matching subsidies). But in negotiations, the state comptroller had offered to increase payments by a much lower amount–$75 million (which, with federal matching funds, could generate up to $150 million in funding). This indicated to us that the state’s cash flows were becoming inadquate to fund its range of priority payments. Therefore, absent the ability to access other state funds which was provided with the enactment of the budget, the court’s ruling mandating stepped-up Medicaid payments threatened to precipitate a liquidity crunch for the state.

In recent years, the balance on Illinois unpaid bills has increased roughly in parallel with the state’s annual fiscal deficits. Consequently, issuing bonds to retire some of the bills might be viewed as tantamount to a deficit financing. And while bonding for current or past operating expenses typically is not a best practice, we believe it is encompassed in the state’s ‘BBB-’ GO debt rating. Furthermore, the unpaid bills themselves are debts of the state. Thus, replacing the unpaid bills with bonds does not represent a net increase in its overall liabilities, though it would increase the state’s annual (fixed) debt service costs. Issuing the bonds would also cause the state’s various debt ratios we consider under our rating methodology to increase. However, key metrics would remain, as they are now, in the ‘moderately high’ range as defined in our criteria (see table below).

As enacted, the General Assembly’s budget legislation authorized up to $6 billion in GO bonds for refinancing the bills. However, as described by the legislative sponsors in the House of Representatives, the budget plan estimated an operating surplus of $360 million, enough to support debt service on approximately $3 billion in GO bonds with a 12-year maturity. Even this may overstate the state’s ability to pay debt service from a budgetary surplus if certain budget assumptions don’t hold. Furthermore, unlike the bill backlog, over which the state retains some flexibility with regard to the timing of repayment, debt service on the bonds would be a new hard cost. But it’s likely that the bonds could be sold at a lower interest cost than what it pays on much of its bill backlog (up to 12%). Therefore, the state may realize net fiscal savings which we believe Illinois can ill-afford to pass up given its weakened financial position, even if the additional debt service adds incrementally to its operating deficit.

At its current rating level, we believe unanticipated liquidity stress remains one of the leading risks to Illinois’ credit quality. Without a budget reserve, the range of fiscal tools available to Illinois with which to navigate a stress scenario is narrower than it is for other states. Throughout its budget impasse, accumulating payables—in effect, shifting the burden of managing a cash flow deficit to its payees—became the state’s de facto approach to liquidity management. However, with nearly $15 billion in unpaid bills as of early July, its ability to continue relying on payment delays was approaching legal and practical limits. The federal court ruling reducing the extent to which the state can delay payments to its Medicaid MCOs illustrated this fact. Retiring a portion of the unpaid bills with proceeds from a GO bond issue implies that in the event of renewed liquidity stress, the state would have restored a portion of its deferral capacity. On its own, implementing the bonding strategy is unlikely to improve the state’s credit quality. However, refinancing a portion of the state’s high interest bill backlog could offer a modest layer of potential cushion to its liquidity. Therefore, the refinancing plan may, to a limited degree, protect Illinois’ credit quality to the downside.

*** UPDATE ***   Pritzker campaign…

According to a new report by S&P Global Ratings, Bruce Rauner’s refusal to refinance state debt is forcing Illinois taxpayers to pay the price and bringing “heightened vulnerability” to the state’s finances. Taxpayers are on the hook for $2 million a day in interest alone on unpaid bills.

S&P says by taking the commonsense step to pay state vendors with bonds, “the state may realize net fiscal savings which we believe Illinois can ill-afford to pass up given its weakened financial position.” The bill backlog is close to $15 billion, nearly triple what it was in June 2015.

“Bruce Rauner’s damage is done after putting our state through a 736-day budget crisis and tripling our bill backlog, so it should come as no surprise that he would skip an opportunity to bring our state out of financial ruin,” said Pritzker campaign spokeswoman Jordan Abudayyeh. “This is a fiscal mess of Rauner’s own creating, and one he is either unwilling or unable to solve.”