Illinois Downgraded Near Junk by Moody's, S&P Over Budget Delay

(Bloomberg) -- Illinois had its bond rating downgraded to one step above junk by Moody's Investors Service and S&P Global Ratings, the lowest ranking on record for a U.S. state, as the long-running political stalemate over the budget shows no signs of ending.

S&P warned that Illinois will likely lose its investment-grade status, an unprecedented step for a state, around July 1 if leaders haven't agreed on a budget that chips away at the government's chronic deficits. Moody's followed S&P's downgrade Thursday, citing Illinois's underfunded pensions and the record backlog of bills that are equivalent to about 40 percent of its operating budget.

“Legislative gridlock has sidetracked efforts not only to address pension needs but also to achieve fiscal balance,” Ted Hampton, Moody's analyst, said in a statement. “During the past year of fruitless negotiations and partisan wrangling, fundamental credit challenges have intensified enough to warrant a downgrade, regardless of whether a fiscal compromise is reached.”

Illinois hasn't had a full year budget in place for the past two years amid a clash between the Democrat-run legislature and Republican Governor Bruce Rauner. That's left the fifth most-populous state with a record $14.5 billion of unpaid bills, ravaged entities like universities and social service providers that rely on state aid and undermined Illinois's standing in the bond market, where investors have demanded higher premiums for the risk of owning its debt. Moody's called Illinois “an outlier among states” after suffering eight downgrades in as many years.

"The rating actions largely reflect the severe deterioration of Illinois' fiscal condition, a byproduct of its stalemated budget negotiations," S&P analyst Gabriel Petek said in a statement. “The unrelenting political brinkmanship now poses a threat to the timely payment of the state's core priority payments."

Illinois's 10-year bonds yield 4.4 percent, 2.5 percentage points more than those on top-rated debt. That spread -- a measure of the perceived risk -- is the highest since at least January 2013 and more than any of the other 19 states tracked by Bloomberg.

The downgrades, which also dropped some debt backed by legislative appropriations into junk, came a day after Illinois's legislature blew the deadline for approving a compromise budget by a simple majority. Now, it takes a higher threshold -- three fifths majority vote in each legislative chamber -- to pass anything. On Wednesday, Rauner, who is up for re-election in 2018, and Democratic House Speaker Michael Madigan, who controls much of the legislative agenda, faulted each other for the unprecedented gridlock.

The governor also held Democrats responsible for Thursday's rating cut.

“Madigan's majority owns this downgrade because they didn't even attempt to pass a balanced budget, get our pension liability under control, and other changes that would put Illinois on better financial footing,” said Eleni Demertzis, a spokeswoman for Rauner. “The governor will continue working toward a truly balanced budget with changes to our system to grow jobs and provide real and lasting property tax relief.”

“Her comment is typical Rauner incompetence, and that's too bad,” said Steve Brown, a spokesman for Madigan.

By June 30, the state will owe an estimated $800 million in interest and fees on the unpaid bills that have been piling up, according to estimates from Comptroller Susana Mendoza, a Democrat. She warned of "dire" consequences for residents if a budget isn't reached by the start of fiscal year 2018 on July 1, including the shuttering of more social service providers and layoffs at public universities. With only a month to go before the start of fiscal year, the ratings cut wasn't unexpected.

“We're going to start to see some real pain now,” Senate President John Cullerton told reporters in Springfield on Wednesday. “We're going to start to see downgrades. We don't have any funding for schools. We don't have any funding for higher end and a bunch of social programs. We don't have a budget.”

Despite the lack of a budget, Illinois has continued to cover payments due on its bonds, and, like other states, has no ability to resort to bankruptcy to escape from its debts. A downgrade to junk, though, would add further financial pressure by increasing its borrowing costs and preventing many mutual funds from buying Illinois's securities.

To contact the reporter on this story: Elizabeth Campbell in Chicago at ecampbell14@bloomberg.net.

To contact the editors responsible for this story: Christopher Maloney at cmaloney16@bloomberg.net, William Selway