Illinois proposal to let treasurer buy unpaid bills likened to a 'shell game'

BY SourceMedia | MUNICIPAL | 05/30/18 07:07 PM EDT By Yvette Shields

CHICAGO – One analyst says legislation to empower the Illinois state treasurer to provide state funds to buy up overdue bill vouchers could add to future fiscal problems.

“When governments start to think creatively about debt structure and repayment, we get a bit nervous,” Lisa Washburn, a managing director at Municipal Market Analytics, wrote in the firm’s weekly outlook commentary. “Any short-term fiscal relief from the legislation (if passed) is likely to be outweighed by the longer-term consequences of failing to substantively address the state’s financial challenges.”

Backers say the legislation will lower the state's interest costs and speed up bill payments to vendors in need of what they are owed.

But another buyside analyst said the vouchers are for a bad investment for the state.

According to Washburn, “the transaction could optically lower the state’s headline-producing bill backlog” and “could reduce interest costs,” but longer term “it also could be the start of a shell game that saddles the treasurer with less liquid, politically charged investments, defers real progress on addressing the bill-backlog, and could amplify Illinois’ fiscal woes if its finances continue to deteriorate.”

Senate Bill 2858, sponsored by Sen. Heather Steans, D-Chicago, seeks to help whittle down the state’s $6.8 billion backlog and curtail the state’s interest tab for its overdue bills. Some Republicans have joined as co-sponsors.

“This is a winning strategy to make more headway on the bill backlog,” Steans said during a legislative hearing on the bill.

Treasurer Michael Frerichs is hopeful it will pass by the legislature’s Thursday deadline.

The legislation originally would have given Frerichs status as a qualified purchaser under the state’s vendor payment program and allow the office to purchase qualified account receivables from state vendors awaiting payment for 90 days or longer. Currently, account receivables are not a permitted investment. The approved amendment instead allows the state treasurer to provide up to $2 billlion of state funds to the comptroller to pay down bills when at least $1 billion is outstanding, but the treasurer wouldn't be part of the vendor payment program.

The state has whittled the backlog down from a record $16.7 billion in the fall after borrowing $6 billion of general obligation debt. The bills piled up during the state's two years without a budget. Gov. Bruce Rauner’s administration estimates the fiscal year will end June 30 with a $7.7 billion backlog.

The state’s overdue bills under the prompt payment act accrue interest at up to 1% monthly with more than $1 billion in interest paid over the last several years.

The treasurer would receive an interest rate from the comptroller tied to the London Interbank Offered rate, federal funds rate, or an equivalent market established variable-rate, which would have to be lower than the state’s penalty rate. The two constitutional offices would enter into an intergovernmental agreement setting interest rates and repayment terms.

Under the existing vendor purchase programs, four financing firms are permitted to purchase overdue bills and collect the 9% to 12% interest. The firms have warned that the state is far in arrears on interest payments, which threatens their future ability to participate in the program.

In addition to trimming state general fund interest costs, the treasurer's office would earn a higher rate than on many other of the state’s permissible investment vehicles. The treasurer manages a $12 billion to $15 billion state investment pool.

Washburn likened the move to actions, albeit on a much smaller scale, taken by the Puerto Rico Government Development Bank which financed the commonwealth and several of the commonwealth’s corporations and carried loans and investments as assets on its books that eventually ran into trouble.

“When the ability of the commonwealth to finance itself in this way came to an end, the GDB’s fiscal position unraveled quickly since it was essentially a creditor to its insolvent self on its non-performing assets versus holding assets from unrelated third-parties,” she writes. “While the scale of the IL self-investment is planned to be markedly smaller than the commonwealth’s deficit borrowing/hiding scheme, it is a troubling development nonetheless.”

Cumberland Advisors is a critic of the state’s vendor program established in 2011 and believes the state’s fiscal ills add uncertainty to payment prospects.

“In addition to kicking the can down the road, the VPP program has increased costs to the state and has likely strained relationships with its vendors and other creditors,” Patricia Healy, senior vice president of research, wrote in a May 14 commentary.

Due to the state’s fiscal ills, Cumberland won’t buy the state’s debt or the securitization bonds some qualified purchasers sell. The securities are non-rated private placements. “Since they are a derivative of the state, they are not liquid; and the timing of the repayment stream is uncertain,” the Cumberland report says.

Given Cumberland’s position, the bills make for a bad investment for the state too. “The proposed ‘refinancing’ of the receivables is another method of trying to kick the can down the road and not addressing the structural imbalance that exists,” Healy said in an email.

The expanded program “may also be a signal that the VPP is coming under more pressure from vendors and qualified purchasers,” Healy added. “It’s a testament to the divide - or otherwise would be surprising - that paying 9% to 12% for unpaid bills…hasn’t been enough to get the financial house in order. Not to mention the downgrades the state has endured.”

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.