Fitch eases pressure on Illinois

BY SourceMedia | CORPORATE | 07/17/17 07:04 PM EDT By Yvette Shields

CHICAGO – Illinois got bond rating relief relief from a second agency following passage of a fiscal 2018 budget with $5 billion of tax increases.

Fitch Ratings Monday removed Illinois from Rating Watch Negative and affirmed its BBB rating on $26 billion of general obligation debt. Fitch also affirmed the BBB-minus on state supported debt including $414 million of sports authority bonds, $2.6 billion of Metropolitan Pier and Exposition Authority bonds, and $268 million of Chicago motor fuel bonds.

The Fitch action follows S&P Global Ratings, which took the state’s BBB-minus rating off watch Wednesday and assigned a stable outlook. Illinois still awaits the results of a rating review by Moody's Investors Service (MCO), which rates Illinois at the lowest investment-grade notch of Baa3.

The Fitch outlook is negative. It had put Illinois on watch in February after a downgrade and had warned that further deterioration lay ahead if the state entered a third fiscal year on July 1 without a budget or progress on shoring up its rocky finances. The state’s GOs are rated two notches above junk.

“The affirmation of Illinois' ratings follows the passage of a fiscal 2018 budget that incorporates a permanent increase in taxes to more closely align revenues with spending and that should significantly reduce the near-term liquidity stress that had threatened the state's investment-grade rating,” Fitch’s lead Illinois analyst Karen Krop wrote.

Fitch tempered the positive news, saying the state's financial resilience has been materially weakened by the two-year budget drought as spending outpaced revenue leaving the state it with a nearly $15 billion backlog of bills. That adds to the strain of dealing with $126.5 billion of unfunded retiree obligations that were not addressed in the deal that ended the two-year budget stalemate.

“These factors result in a rating well below the level that the state's solid economic base and still substantial independent legal ability to control its budget would support,” Fitch said.

Democrats, who were joined by some Republicans, passed a $36 billion budget and $5 billion tax hike package earlier this month and then successfully overrode Gov. Bruce Rauner’s vetoes. Deep political strains remain and a fight over education funding looms.

“Illinois has demonstrated a repeated inability to address its structural challenges due to an absence of consensus and resistance among key stakeholders. The political environment in the state remains a negative rating consideration,” Fitch added.

Fitch remains concerned over the state’s ability to reduce the backlog that includes an initial borrowing of $3 billion to help pay down, meeting revenue targets in a slow growth environment, and achieving near-term pension contribution savings, partly at the expense of worsening the state's long-term liability picture.

The state’s liquidity strains remain pressured especially a federal court order to pay Medicaid providers nearly $600 million monthly which limits the state ability to manage bill payments.

The state’s rating could sink if it fails to meet the assumptions incorporated in the fiscal 2018 budget or materially improve the state's stressed liquidity environment, Fitch said. The budget cuts $2.5 billion in spending and relies on $1.5 billion in pension savings.

Positive rating action is not likely until the state more comprehensively addresses its accumulated liabilities. One source of future flexibility to address the backlog or pension obligations lays ahead in fiscal 2020, when $1 billion annual debt service on bonds issued previously to fund annual pension payments rolls off as the bonds mature.

In general the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so avoiding losses caused by price volatility by holding them until maturity is not possible.

Lower-quality debt securities generally offer higher yields, but also involve greater risk of default or price changes due to potential changes in the credit quality of the issuer. Any fixed income security sold or redeemed prior to maturity may be subject to loss.

Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.

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