Illinois Bonds Fall as Budget Impasse Pushes Rating Toward Junk

(Bloomberg) -- Illinois bond prices have dropped as Governor Bruce Rauner and lawmakers remain locked in two-year stalemate over the government’s budget, increasing the chance that it may become the first U.S. state ever cut to junk.

Illinois’s 10-year bond yields, which move in the opposite direction as price, have soared to about 5.2 percent, or 3.36 percentage points more than top-rated municipal debt, according to Bloomberg’s indexes. Securities due in 2023, the most actively traded Friday, sold for an average yield of 4.3 percent, a nearly half percentage point jump since May 31, the day before S&P Global Ratings and Moody’s Investors Service downgraded Illinois to the lowest investment grade.

The downgrades came after state leaders failed for the third year in a row to approve a spending plan during the regular legislative session, forcing lawmakers to secure a three-fifths majority of the legislature to pass a budget before the start of the next fiscal year on July 1. If they can’t, S&P warned that it will likely cut Illinois’s credit rating again.

Illinois hasn’t had a budget for more than 700 days, driving up the backlog of unpaid bills to a record $14.7 billion and wreaking havoc on entities that rely on state aid, as the Republican governor and the Democrat-controlled legislature remain at odds over what steps to take to eliminate the government’s chronic budget shortfalls. Without a budget in place, Illinois has continued to spend more than it brings in, increasing its financial stress.

The drop in the price of Illinois bonds this week likely reflects anticipation that the securities will be dropped to junk, said Matt Fabian, a partner with Municipal Market Analytics Inc.

“After those downgrades, it became extremely likely that it goes below investment grade,” he said. 

Some of Illinois’s biggest bondholders have said they won’t be forced to sell their securities if the state is downgraded again and anticipate that the political impasse -- which hasn’t kept the government from covering its debt payments -- will ultimately be resolved. Fabian said that while a rating cut will prevent some mutual funds from buying the securities, it generally won’t force them to shed their holdings. 

“If there’s an investor that would have to sell, they likely already did so,” he said. “There’s no surprise about them being cut.”

To contact the reporter on this story: William Selway in Washington at wselway@bloomberg.net.

To contact the editors responsible for this story: Christopher Maloney at cmaloney16@bloomberg.net, Dave Liedtka