S&P Downgrade Brings Illinois Closer to Junk--Update

By Heather GillersFeaturesDow Jones Newswires

Illinois is on the verge of becoming the first state with a junk-bond rating following downgrades from two of the world's largest credit-ratings firms.

S&P Global Inc. warned that Illinois could be downgraded to junk status next month if it doesn't solve its partisan gridlock. The state hasn't had a budget for two years because of a standoff between the Republican governor and Democratic legislature.

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Illinois is one of many states that, despite a generally strong U.S. economy, are struggling to close budget gaps because of pensions and other entitlements. State and local retirement liabilities have ballooned since the financial crisis, and some governments don't have enough assets to cover all future obligations.

S&P on Thursday dropped its grade on the state's general-obligation bonds one level to BBB-minus, the lowest possible investment-grade rating, citing Illinois's inability to pass a budget. Moody's Corp. also dropped its Illinois rating one notch above junk. Fitch Ratings has rated Illinois at two notches above junk.

A downgrade to a junk rating would worsen Illinois's financial straits by likely increasing interest rates it would pay on all borrowings.

Illinois also would have to make millions of dollars in termination payments on existing interest-rate swap contracts, according to S&P. Those penalties would be about $10 million in the event of a downgrade to junk by one rating firm, would reach $19 million if two firms gave the state a junk rating and could reach $108 million in the event of further downgrades.

"By letting the state get downgraded, Illinois's government is only making its own budget problems worse," said Matt Fabian, a partner at Municipal Market Analytics

Analysts for all three ratings firms have said that Illinois has significant economic strengths and that its deteriorating credit is in large part a result of political gridlock.

Prices on some Illinois general-obligation bonds fell to about 99 cents on the dollar Thursday after trading as high as 105 cents earlier in May.

Puerto Rico last month was placed under court protection in what amounts to the largest-ever municipal bankruptcy, owing $73 billion to creditors. That dwarfed the roughly $9 billion in bond debt owned by the city of Detroit when it entered what was previously the largest municipal bankruptcy in 2013.

Puerto Rico, like many governments around the U.S., created problems for itself by borrowing more money to buy time so it could stave off deeper economic overhauls.

But no state had gone without a budget for over a year since the Great Depression until Illinois. While the state is still funding certain core functions, many nonprofits have had to shut down or reduce operations and lay off staff after going without payments from the state.

"In our view, the unrelenting political brinkmanship now poses a threat to the timely payment of the state's core priority payments," S&P analyst Gabe Petek said in his ratings report Thursday.

The budgetary issues in Illinois have rippled well beyond the state capital of Springfield, denting everything from infrastructure spending to the amount of books in elementary schools.

Public universities have been among the hardest hit with many schools pausing on any new construction and forced to stop hiring for vacant positions. Some universities including Northeastern Illinois, Governors State and Southern Illinois are weighing fixes such as raising tuition, cutting academic programs or laying off student workers.

Write to Heather Gillers at heather.gillers@wsj.com

(END) Dow Jones Newswires

June 01, 2017 20:23 ET (00:23 GMT)