Is Illinois getting weaker?

March 20, 2014

Illinois has queued up contestants for the governor’s race this fall. The New York Times reports:

Bruce Rauner, a multimillionaire businessman making his first run for political office, won the Republican nomination for governor of Illinois on Tuesday, setting up what is expected to be one of the nation’s most contested races for governor this fall.

Mr. Rauner, little known to Illinois voters before an intense run of television commercials, is expected to bring a serious challenge to Gov. Pat Quinn, a Democrat seeking a second full term in office. Although control of Springfield, the capital in President Obama’s home state, has been solely in the hands of Democrats for more than a decade, a fierce contest is anticipated, in part because of the economic picture in Illinois, given the state’s poor credit ratings and high unemployment rate compared to other states.

As Rauner begins his campaign sprint to November, he may want to devote time to the study of the dire state of Illinois’ finances. Elizabeth Foos outlined it in a recent Morningstar note — “Illinois’ Net Financial Position Worsens in 2013.” Foos writes:

The state of Illinois released its fiscal 2013 Comprehensive Annual Financial Report, which revealed that the state continues to struggle with cash flow issues, a backlog of unpaid bills, and steep pension and health-care costs.

Translation: the cash drawer is empty. More from Foos (emphasis mine):

The state was able to decrease its general fund deficit by $1.7 billion, but that still resulted in a balance of negative $7.3 billion at the end of the fiscal year. A rise in income taxes and federal funds gave overall revenue a boost and was the largest driver of the improved performance.

Yet expenditures also increased, resulting in the 12th consecutive year that Illinois recorded a budgetary general fund deficit. With both the individual and corporate tax rates set to drop in 2015 and steep costs for pension liabilities and unpaid liabilities coming due, concerns remain regarding the state’s financial stability and growth in the near term.

Translation: a cash flow train wreck.

The New York Times reported that Rauner, in his quest for the Republican governor nomination, spent $6 million of his own money (approximately $18 for every vote he received). It’s curious that Rauner would pay to acquire the helm of Illinois while it appears to be sinking. It will take a strong constitution to fix this.

Bond investors still knock Illinois for the being the lowest-rated mainland state. The Thomson Reuters Municipal Market Data chart at the top shows the amount of interest they demand over a AAA municipal general obligation credit. Interestingly, demand for Illinois bonds maturing before 2019 has increased significantly and spreads over AAAs (yields) have come down over the past year.

Meanwhile investors have less appetite for bonds that are dated longer than 10 years (2024) where spreads have widened. Illinois came into the market to issue bonds several times recently and demand was insatiable for their high interest debt. Bond investors, similar to the situation in Puerto Rico, seem to have little concern for Illinois’ fiscal condition since the bonds are constitutionally guaranteed. There seems to be no “bond market brake” to temper issuance. Reuters reported on March 3:

Illinois’ upcoming bond sale precedes Governor Pat Quinn’s fiscal 2015 budget address, which was postponed to March 26 from Feb. 19. The Democratic governor, who faces re-election this year, has projected income tax revenue will drop by $1.4 billion in the upcoming budget due to the partial expiration on Jan. 1 of tax rate hikes enacted in 2011.

A government finance watchdog group on Monday warned that a tax rate rollback would ‘dramatically destabilize Illinois’ already weak financial condition.’

I concur with the New York Times’ statement that Illinois will be “one of the nation’s most contested races for governor this fall.” When the ballots are counted and the winner is declared, big steps will be needed to address the fiscal problems of Illinois. All eyes on the nation’s fifth most populous state.

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Given what just happened in PR, one can only conclude that the muni market is credit-insensitive. It’s Minsky Moment hasn’t happened yet.

Posted by nixonfan | Report as abusive