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Moody’s tries to explain its Illinois outlook revision

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Illinois

* From a Moody’s press release yesterday…

We revised Illinois’ outlook to negative because it aligns with Moody’s view of the probable effects of the coronavirus pandemic, which will reduce tax collections and likely cause current-year pension investment losses, both of which would weigh more heavily on Illinois, given its existing weaknesses relative to other states. Federal government support will mitigate some of the direct budgetary burden, but the state will face liquidity pressure that may lead it to near-term actions such as adding to its balance of unpaid bills. The state is also increasingly likely to take actions that worsen its long-term liabilities, in view of revenue shortfalls and growing health and social burdens.

* Greg Hinz looked at the new report…

How Illinois’ fares now will depend on not only the track of the epidemic but how much financial relief it gets from the federal government, something that certainly was on the mind of Illinois Senate President Don Harmon with that controversial letter a few days ago, in which he pleaded for a bailout.

Another is whether voters in November approve Gov. J.B. Pritzker’s proposal to authorize a graduated income tax.

“Voter approval, which is far from assured, would add some revenue volatility but would greatly improve flexibility to respond to pension contribution and other spending needs as well as shifting economic conditions,” the agency wrote in a comment Pritzker surely noticed. “Rejection of the amendment probably will force the state to consider other alternatives, such as aggressive spending reductions, an increase in the existing flat income tax rate or application of the state sales taxes to services.”

Overall, it concludes, the state generally should fare about as well as other large-economy states in the recession that’s now underway. And liquidity is good—at the moment.

* I read the initial press release and asked a Moody’s spokesperson if the firm had any evidence that Illinois would skip bond payments. The emailed reply…

The short answer is “no.”

* So, I said, if there’s no evidence of that happening, why put Illinois a hair above junk status? The reply…

Well, that goes back to our rating scale. I can talk you through it at some point if you want but there’s 21 total ratings with about half considered “investment grade” (Aaa to Baa3) and the rest below (Ba1 and lower). We call the latter “speculative grade” but everyone else calls it “junk.”

At the end of the day, the ratings translate to bondholders how risky a bond is and what the chances are they’ll be fully repaid with interest. The higher the rating, the greater the likelihood and vice versa. Since there’s multiple levels of speculative grade ratings, the lower the rating the higher the chance of default (and the higher the risk to bondholders).

We rate about 8500 municipal issuers across the country and I’d be surprised if we had 400 ratings below investment grade. Municipal issuers are extremely resilient and defaults and bankruptcies are very rare. But if a rating is downgraded below investment grade that does not automatically translate to default. It means we think the chances are higher than before.

Remember Chicago is rated Ba1, the highest “junk” bond level and one below the state. But Chicago has been at that position for a few years now and has not defaulted. CPS is rated three notches lower than the city at B1 because we consider them a much higher risk than the city. But at its nadir a couple of years ago CPS was rated two notches lower at B3 and may have defaulted if the state had not assisted.

This might be too wonky already, but in speculative grade the ratings also translate into likely recovery rates for bondholders if there is a default. The lower the rating the lower the recovery expected. Puerto Rico’s debt is rated either Ca (35-65% recovery expected) or C (35% or less) and Puerto Rico has defaulted on almost all its debt.

One last item to note: Our records go back to 1970 and we’ve never had a state rated below investment grade. The median state rating is Aa1, our second highest and eight notches higher than Illinois.

Thanks for reading and hope that clears things up,

It didn’t.

* Meanwhile…

The onetime head of Fitch Ratings’ Public Finance Group is blasting the firm’s decision [last week] to immediately downgrade Illinois debt, calling it “premature,” instead of giving officials a chance to resolve financial woes amid a fast-moving COVID-19 pandemic.

Mike Belsky said the pandemic still has too many uncertainties to make a judgement on its fiscal impact here. Belsky is now executive director of the Center for Municipal Finance at the University of Chicago’s Harris School of Public Policy. […]

Belsky said Fitch apparently did not follow its normal course of sitting down with management—in this case, state financial officials—to discuss what sort of response they might make to souring finances. “Management now is stretched, drinking from a fire hose” and properly focused on medical issues, he said. “There’s no doubt that Illinois is going to be challenged.”

posted by Rich Miller
Wednesday, Apr 22, 20 @ 9:50 am

Comments

=The state is also increasingly likely to take actions that worsen its long-term liabilities,=

Your move Madigan and Pritzker.

Comment by Flat Bed Ford Wednesday, Apr 22, 20 @ 9:57 am
All one needs to know about these agencies is the tune they were singing shortly before the housing bubble burst.

Comment by efudd Wednesday, Apr 22, 20 @ 9:59 am
I forgot who was very smart and wise and added -Wordslinger -‘s thoughts to the initial post Rich had up about the ratings. It was well played and well done… and another instance where I find myself missing him.

To the post,

In that spirit, and I’ll look back who commented and got that - Wordslinger - grab, but in the meantime, that word salad Moody’s gave Rich about knowing (or not knowing) if Illinois would skip a payment… it’s telling… that even Moody’s is confused to their own role, and how to apply their own thoughts based solely on… speculation.

In actuality, they explained quite a bit about their own lacking.

Comment by Oswego Willy Wednesday, Apr 22, 20 @ 10:02 am
That’s a whole lot of extra letters in BS.

Comment by Excitable Boy Wednesday, Apr 22, 20 @ 10:03 am
The historical default rate for all 50 states bonds over their history of existence does not match up with the ratings and ‘explaining’ that Moodys is making here.

I can’t put my finger on the exact issue, but the mismatch between the historical bond environment, and how moodys seems to be taking an active role in pushing Illinois into a lower rating, has a stink of an ulterior motive. I have no evidence, but a little digging would be in order.

Comment by TheInvisibleMan Wednesday, Apr 22, 20 @ 10:05 am
One thing to keep in mind with the 5 State pension systems is that the systems already certified what the FY 2021 payment will be. So everything that happened this year so far, doesn’t affect what the State will pay in during FY 2021. And after that, investment gains and losses are smoothed out over 5 years to prevent a sudden shock, but those losses will obviously be realized eventually.

Comment by My Button is Broke... Wednesday, Apr 22, 20 @ 10:06 am
Harmon was right to send the letter.

Greg Hinz lays it out: “How Illinois’ fares now will depend on not only the track of the epidemic but how much financial relief it gets from the federal government, something that certainly was on the mind of Illinois Senate President Don Harmon with that controversial letter a few days ago…”

Harmon has been a bond lawyer for 20+ years. He knows how the rating agencies think.

Maybe the Governor’s team could listen.

Comment by Scott Cross for President Wednesday, Apr 22, 20 @ 10:07 am
Translation of Moody’s statement and clarification:

We don’t think it will happen but we have to justify our jobs and cover our rear ends just in case the 0.001% chance of a bond default occurs sometime in the future.

Comment by RNUG Wednesday, Apr 22, 20 @ 10:08 am
=== Harmon was right to send the letter.===

With respect, it’s debatable at best.

Gov. Pritzker said it best yesterday when asked about the letter;

=== I don’t think there’s anything that can be more effective than a governor calling…===

If Mr. Harmon would like to give counsel, or be a voice, blindsiding with an “agenda-partisan” letter won’t have the juice like any governor would have.

Just a counterpoint. Respectfully.

Comment by Oswego Willy Wednesday, Apr 22, 20 @ 10:14 am
Rich, the explanation is simple. Too many people in Illinois make their livelihood off of state government, and to us all of it is justified. It’s just that the numbers don’t add up into the future.

We can’t balance our budget, for reasons that are eminently reasonable to us. But people are fleeing Illinois, lowering our congressional representation and shrinking our tax base.

We might get a progressive income tax, but enough to close the budget deficit? Is anyone even talking about paying off liabilities? Anybody? Anybody?

We may not be, but the rating agencies are.

Comment by First Amdt Lawyer Wednesday, Apr 22, 20 @ 10:14 am
Wordslinger used to remind people that Illinois never skipped out on bond payments. Right wing bust out artists want us to default so the pension systems and public sector can be blown up. ILSC made clear that state government has the responsibility to help improve state finances. It has the tools as well.

As for the graduated income tax, proponents have the resources to get the message out that the alternatives to no graduated income tax are a lot worse.

Comment by Grandson of Man Wednesday, Apr 22, 20 @ 10:18 am
=== but enough to close the budget deficit? Is anyone even talking about paying off liabilities? Anybody? Anybody?===

You must’ve missed the Quinn years, and what happened with the tax increase, and what happened in the Rauner years too.

Welcome to Illinois.

Do just a lil work, or continue to be willfully ignorant or blissfully unaware.

Also, explain the constitutional obligations.

Comment by Oswego Willy Wednesday, Apr 22, 20 @ 10:22 am
@Moody’s: Your statement is not too wonky..it’s just BS.

Comment by Annoyed Wednesday, Apr 22, 20 @ 10:23 am
What @efudd said. I will never be able to get past the fraud perpetrated by the rating houses that helped implode the global economy. In the end, no prosecution for selling ratings. When I was involved in rating calls when our district issued bonds I wanted to go off but somehow surpassed the urge.

When our district issued bonds we were told we paid a premium for being in Illinois. Absolutely ridiculous since, as indicated by evidence, there is no record of Illinois defaulting on bonds. The ratings then are invalid and simply used to raise costs on Illinois. Is that political? Probably. Definitely greedy.

then there is this-

=CPS is rated three notches lower than the city at B1 because we consider them a much higher risk than the city. But at its nadir a couple of years ago CPS was rated two notches lower at B3 and may have defaulted if the state had not assisted.=

Bond rates (the portion of a districts levy that generates revenue to pay bonds) are uncapped. When has an Illinois school defaulted on bonds? It works much the same as the state. A complete joke.

When Rich asked the question about junk, he got the condescending (I think) explanation of what a rating is and it did not actually answer the why, given more than a century of evidence, that Illinois does not default, is the rating so low. This is especially telling since the state has weathered two global financial calamities in that time and never missed a bond payment.

If we had a real AG in Washington maybe he would look at that since it is a national issue. Illinois’ AG ought to try to investigate as well.

Comment by JS Mill Wednesday, Apr 22, 20 @ 10:23 am
RNUG nailed it

Comment by illinifan Wednesday, Apr 22, 20 @ 10:29 am
What OW said about Harmon… x100… OW, what do you make of Da Mayor saying she wants Chicago extended without the Gov weighing in. Again, I can’t say enough, I did not vote for JB. But he is MY Gov. He is taking his time and being thoughtful for health and business. I don’t appreciate anyone jumping him. Unless I am being too sensitive.

Comment by CCM Wednesday, Apr 22, 20 @ 10:30 am
+1 RNUG. The simple matter is that the rating is not related to the likelihood of default for states. Therefore, Moody’s and Fitch are peddling a system not fit for purpose. Either change your system or pack it in.

Comment by Jibba Wednesday, Apr 22, 20 @ 10:35 am
There’s a reason many municipal issuers have stopped paying Moody’s to rate their debts. They moved so beyond “odds of a default” it is dumb. The State’s bond holders get paid on top of the revenue waterfall so regardless what happens at the bottom they are safe. The rating agencies choose to ignore that point.

Comment by Former Bartender Wednesday, Apr 22, 20 @ 10:36 am
- CCM -

Appreciate it. To your thought?

=== …saying she wants Chicago extended without the Gov weighing in.===

I’d like to think both the Mayor and the Governor will be in concert here, and while Mayor Lightfoot likes to be her “act”, this whole crisis is a group project, so words are that, and I’d be more surprised if both offices/crews aren’t working out what things will look like in how the state and city will go about the business of this crisis.

Shorter? I’m watching what happens not so much what’s said to next actions.

Stay well.

Comment by Oswego Willy Wednesday, Apr 22, 20 @ 10:38 am
I don’t think there’s anything malicious about the downgrade. It is an unfortunate reality but reflective of the higher risk that the state’s bonds carry with them now. I hear everyone singing loud and clear about how we’ve never missed a payment, but I think it’s also fair and necessary to remind ourselves, that we’ve never gone through ANYTHING like this before. This is not like, and will not be like any of the recessions we’ve been through before. Trying to extrapolate future behavior based on past performance is dangerous in this environment. Look at the charts for unemployment claims and what May and June crude oil futures contracts look like. Nobody is immune to the kind of economic fallout that will result from what’s happening. In this environment, about the only thing you can guarantee is that there will be increased risk for investors anywhere and the downgrades justifiably reflect that. They’ll come all across the board. We’re just some of the low-hanging fruit that gets picked on first.

Comment by Chambanalyst Wednesday, Apr 22, 20 @ 10:39 am
My interpretation is that the phrases “Speculative” or “junk” are too strong, at least in common language. They said there are different levels of junk, so being rated as the highest level of junk doesn’t mean a default is probable, just slightly more possible. Splitting some pretty fine hairs there.

Comment by Perrid Wednesday, Apr 22, 20 @ 10:48 am
@CAPFAX readers - how about we start our own fund that invests solely in Illinois debt? The return will be better than my current fixed income portfolio. Wonder what the name of the fund should be..

Comment by Annoyed Wednesday, Apr 22, 20 @ 10:50 am
=that we’ve never gone through ANYTHING like this before=

Yeah, they say that every time. The FACT remains, there has never been a bond default by Illinois. You can’t use past performance as a factor and then ignore it when it is inconvenient for the purpose of raising rates. The risk for Illinois bond holders is almost zero.

Comment by JS Mill Wednesday, Apr 22, 20 @ 10:51 am
===The median state rating is Aa1, our second highest and eight notches higher than Illinois.====
Well, looking at it as the glass is half full, we are in the top half of the rating notches. 9th out of 21. We have 12 more notches to fall before we hit bottom.

Comment by Been There Wednesday, Apr 22, 20 @ 11:02 am
===They’ll come all across the board. We’re just some of the low-hanging fruit that gets picked on first.===

The fact that they haven’t come across the board is what should be the eye-opener in Moodys statement.

If you believe everything else you wrote - which seems more informed by wirepoints and zero hedge articles - then you can’t at the same time honestly justify a movement in one states ratings but not for any other states.

Comment by TheInvisibleMan Wednesday, Apr 22, 20 @ 11:09 am
here we go, Senate looking at giving states bankruptcy protection.Senate Majority Leader Mitch McConnell said Wednesday he favors allowing states struggling with high public employee pension costs amid the burdens of the pandemic response to declare bankruptcy rather than giving them a federal bailout.

“I would certainly be in favor of allowing states to use the bankruptcy route,” he said Wednesday in a response to a question on the syndicated Hugh Hewitt radio show. “It’s saved some cities, and there’s no good reason for it not to be available.”

Comment by 44th Wednesday, Apr 22, 20 @ 11:17 am
” .. has a stink of an ulterior motive.”
The ulterior motive is ratings agencies are tough to an unwarranted degree on the government market, to compensate for the fact they’re in the toilet for the private market. Still.

https://www.barrons.com/articles/the-sec-fix-for-conflicts-of-interest-at-credit-ratings-firms-has-failed-51572426600

Comment by Anyone Remember Wednesday, Apr 22, 20 @ 11:26 am
=== Senate looking at giving states bankruptcy protection===

Does it need to go thru the House?

How go you think that’d go?

Comment by Oswego Willy Wednesday, Apr 22, 20 @ 11:45 am
44th

I saw that reported in Bloomberg as well. McConnell specifically called out Illinois & a few other states. He is not supporting bailing out city/state pensions with federal money

Comment by Silicon Prairie Wednesday, Apr 22, 20 @ 11:50 am
Look for Hurricane Mitch to exempt bonds from bankruptcy so that the burden falls only on lowly humans.

And maybe Moody’s can show us the calculations where any of their ratings categories for states make sense when the black swan event of bankruptcy is allowed.

Comment by Jibba Wednesday, Apr 22, 20 @ 12:09 pm
==I think it’s also fair and necessary to remind ourselves, that we’ve never gone through ANYTHING like this before.==

OK. So bad it would completely dry up revenues? Because that’s what it would take. The state’s General Obligation Bond Act provides an “irrevocable and continuing appropriation of all amounts” to pay bond principal and interest, even if there is not enough money in the GRF and Road Fund and even if the GA fails to appropriate the amount needed to make payments. That’s pretty much checkmate, man. Bondholders are going to get paid.

Comment by John Deere Green Wednesday, Apr 22, 20 @ 12:40 pm
For all the gleeful.., the ones cheering destruction and ridiculous asks;

Read that take by - John Deere Green -

It’s more of a “I understand how this all works” than a take, so don’t hyperventilate.

Comment by Oswego Willy Wednesday, Apr 22, 20 @ 12:44 pm
Of course Mitch McConnell is going to try to benefit from this crisis, he is Trump’s chief protector and enabler and bankruptcy is the Tool in Chief’s second favorite tool (second only to lying). As OW stated, the house stands in the way of Moscow Mitch and this hands the democratic party another point for November because a lot of workers just got reminded of how little they are valued by their would be owners.

Comment by former southerner Wednesday, Apr 22, 20 @ 12:59 pm
Is the General Obligation Bond Act a statute that can be changed by a simple majority? While I think that weakening it would violate the federal contracts clause, our state legislators might try it.

To me the threat of default is political, not economic. Our political leaders have underfunded pensions for more than a century. They passed a bill trying to take money from retirees. It was struck down by the Illinois Supreme Court, but the attempt was serious.

Would our political leaders cut payments to bondholders if they could? Recent history says yes. If the Democratic majority would hurt retirees, they would have little problem hurting (presumably rich) bondholders.

Likely? No. Possible?

Comment by Last Bull Moose Wednesday, Apr 22, 20 @ 1:07 pm
Last Bull Moose: IMO, The passage of SB1 to change tier 1 pensions was more of an attempt to gain ISC clarity on the protrction clause and have political cover once it was struck down.

Comment by Just A Dude Wednesday, Apr 22, 20 @ 1:17 pm
==To me the threat of default is political, not economic.==

Let’s say your hypothetical came to pass. If the ratings agencies hadn’t yet dropped Illinois GO bonds to junk, such a deleterious action by lawmakers would do the trick. That eliminates a number of investors prohibited from investing in speculative grade bonds. For the ones who are left, the legislature just eliminated an iron-clad protection of their payments. So who’s going to be investing in Illinois bonds? The highest of the high-stakes gamblers who just lost their guarantee. And you don’t think there’s an economic threat there?

Comment by John Deere Green Wednesday, Apr 22, 20 @ 1:51 pm
I live and work here, and have for my entire life, so let me be clear that I’m not “cheering” gloom and doom for the state. I don’t actually believe the state would default on bond payments and I acknowledge the GOBA’s language regarding that. But I can be a realist and acknowledge that the risk reward calculus is different in this environment and a small rating change is appropriate to reflect that adjustment. I also think it would be quite alarming to everyone if the agency issued mass downgrades for other states and municipalities across the board. Maybe I am wrong, hopefully I am and subsequent downgrades don’t happen. But it is hard to be optimistic these days.

Comment by Chambanalyst Wednesday, Apr 22, 20 @ 2:37 pm
By political and not economic I meant that threat is not from economic inability but from political will. The pension change to Tier One may have just been political gamesmanship. I think it cost Pat Quinn reelection and gave us Rauner.

I hope our politicians are too smart to try games with this.

Comment by Last Bull Moose Wednesday, Apr 22, 20 @ 3:56 pm