Illinois won a one-notch upgrade Tuesday from Moody’s Investors Service, action that turns the rating tide for a state stung by more than a decade of downgrades that left it one cut away from a speculative grade.
Moody’s moved its general obligation and Build Illinois sales tax-backed ratings up one level to Baa2 from Baa3. It continues to assign a stable outlook.
Illinois’ management through the COVID-19 pandemic and prudent actions with its rosier revenue projections and $8.1 billion in new federal relief from the American Rescue Plan Act drew Moody’s praise.
“The upgrade of Illinois’ GO rating to Baa2 from Baa3 is supported by material improvement in the state’s finances,” Moody’s lead Illinois analyst Ted Hampton said in the report. “The enacted fiscal 2022 budget for the state increases pension contributions, repays emergency Federal Reserve borrowings and keeps a backlog of bills in check with only constrained use of federal aid from the American Rescue Plan Act.”
Gov. J.B. Pritzker this month signed a new budget that mostly holds spending levels, includes $655 million of recurring revenue by eliminating corporate tax breaks, and uses rosier revenue projections to retire early $2 billion of three-year borrowing through the Federal Reserve’s Municipal Liquidity Facility.
The budget also repays $928 million of inter-fund borrowing used for cash flow and budget management earlier in the pandemic. The state’s backlog of overdue bills hovers at its lowest levels in years around $3 billion to $3.5 billion after hitting $16.7 billion in 2017.
The rating upgrade impacts $33 billion of bonds, including $27.7 billion of GOs, $1.9 billion of Build Illinois sales tax bonds, and $1.9 billion of Metropolitan Pier and Exposition Authority bonds.
“The stable outlook indicates the state’s capacity to manage near-term fiscal pressures while carrying a heavy long-term liability burden,” Moody’s said. The longer report that digs into the rating agency’s reasoning for the upgrade was not yet available.
Illinois’ ratings remain the lowest among states and the fiscal 2022 budget did nothing to ease the state’s most chronic and daunting strain: $141 billion of unfunded pension liabilities.
“Illinois still faces longer-term challenges from unusually large unfunded pension liabilities, which are routinely shortchanged under the state’s funding statute. These liabilities could exert growing pressure as the impact of federal support dissipates, barring significant revenue increases or other fiscal changes,” Moody’s warned.
But for now, Pritzker basked in the good news that comes after Fitch Ratings moved the state’s outlook to positive from stable. Fitch and S&P Global Ratings both rate the state at the lowest investment grade of BBB-minus. S&P assigns a stable outlook.
“I promised to restore fiscal stability to Illinois and Moody’s ratings upgrade demonstrates that Illinois’ finances are heading in the right direction for the first time in two decades. A ratings upgrade pays momentous dividends for taxpayers, and the people of Illinois deserve credit for their incredible resilience and determination,” Pritzker said in statement.
Aside from giving the state a buffer between junk and investment grade, the action also moves the Metropolitan Pier and Exposition Authority’s rating into investment grade territory as it’s notched one below the state due to an appropriation requirement.
Factors that Moody’s said could drive further positive rating movement include enactment of recurring financial measures that move the state toward structural balance, decisive action to improve pension funding, and improvements to the state’s governance profile, such as constitutional or legal changes, that are likely to have a lasting effect.
The state’s pension benefits are protected by a constitutional provision that bars impairment or diminishment of benefits. Some believe a constitutional amendment could alter the landscape but Pritzker, a Democrat, does not back such a move. Measures that add to the state’s pension woes, a growing structural imbalance, or significant increase in the bill backlog could drive a downgrade.
In the spring of 2020 Fitch cut its rating one notch to BBB-minus; all three agencies moved their outlooks to negative due to pandemic pressures. Moody’s and S&P this spring restored the stable outlooks and Fitch last week moved the outlook to positive.
Moody’s last moved the state’s rating upward in 2010, a two-notch move Aa3 driven by a broad recalibration of municipal bond ratings.
The last formal Moody’s upgrade came in 1998. It’s been downhill since and hit Baa3 in June 2017 during the state’s two-year budget impasse as then Gov. Bruce Rauner, a Republican, battled with the Democratic-led General Assembly.
Fitch has not raised the state’s rating since its recalibration of ratings in 2010 and the last upgrade outside of recalibration occured in 2000. S&P has not upgraded the state since 1997, according to the Illinois Commission on Forecasting and Accountability.
It’s unclear whether the upgrade will drive any further narrowing of Illinois’ spreads. The state has already reaped market rewards with its spread penalties narrowing this month to levels in line with its ratings for the first time in years thanks to market demand for any extra yield and its improved fiscal condition.
The state’s 10-year spread currently stands at 65 basis points higher than Refinitiv Municipal Market Data’s AAA benchmark and the yield of 1.66% is close to the 1.62% for the BBB benchmark. A year ago it was at a 325 basis point spread to the AAA compared to 139 basis points in 2019 and 174 basis points in 2018. The Fitch positive outlook did not drive any further narrowing and spreads actually widened by two basis points based on market conditions over the last week.