Rauner Inherits Illinois Downgraded by Bond Market: Muni Credit

To correct the finances of the lowest-rated US state, Illinois Governor-elect Bruce Rauner won a mandate. Investors agree that the newly elected Republican Governor has a tremendous amount of work to do in order to prevent a credit downgrade closer to junk

As part of Rauner’s campaign, he pledged to bring new life to Illinois, a state with the worst-funded US state pension system. However, Illinois faces another huge problem of having a budget created on tax increases that are scheduled to end in just seven weeks.

According to Nuveen Asset Management, responsible for $97 billion of munis, unless appropriate measures are taken toward a fiscal rebound, Illinois will likely get a rate cut.

Based on trading in the $3.7 trillion municipal market, it appears a reduction is already set. The 10-year debt for Illinois yields 3.72%, compared to a benchmark index of revenue bonds graded BBB at 3.13%, down two steps. If the S&P cuts the state, Illinois would drop to within only three steps of junk. At this grade, it is the worst the S&P has given any state in over 10 years.

Illinois has been cut and given negative outlooks since the beginning of last year by the S&P, Fitch Ratings, and Moody’s Investors Service. Together, the three rank the state just four levels above junk, with S&P and Fitch grading it an A- and Moody an A3.

Dan Heckman, senior fixed-income strategist with Kansas City-based US Bank Wealth Management and responsible for overseeing $120 billion said the spread clearly shows there is a lot of work to be done. However, there is hope that the Governor will take the right steps to help improve things.

As a result of Rauner’s victory over Democratic opponent Pat Quinn, it was the first time in 16 years that a Republican became the elected chief executive of Illinois. Rauner says he will work with the Democrat-controlled legislature in addressing fiscal changes, which includes a pension shortfall of $100 billion, as well as unpaid debt in the amount of $4.9 billion.

Rauner added that throughout his race for Governor, he stayed committed to working with the Democratic side to find bipartisan solutions to the state’s economic and fiscal issues while striving to once again make Illinois a pro-growth state.

John Sudgen, analyst at New York’s S&P said in an interview there is significance to Rauner’s statement and that a decision would be taken seriously. Rauner who will officially take office on January 12, is being given time by ratings companies to prepare proposals. As stated last week, Rauner will start by addressing the tax issue no later than the middle of the month, to include talks with lawmakers on both the Republican and Democratic side.

Analyst at Fitch Karen Krop said that as a new Governor, Rauner has a great opportunity to present a plan although at this time, no one knows what it will entail.

If the state of Illinois gets a lower rating, it could provide leaders with political cover to make changes deemed unpopular. Ty Schoback, senior analyst at Columbia Management Investment pre-Advisers LLC who handles $30 billion in munis said most experts recognize to get politicians to make difficult but necessary choices, a good crisis to hide behind is needed.

Lawmakers will address the tax levels when there are enough votes to pass a bill, this according to Steve Brown, spokesman for House Speaker Michael Madigan. Rauner wants to stop the income-tax increase, as well as the higher corporate levy.

Amanda Kass, research director with the Center for Tax and Budget Accountability said it is impossible to cut a way out of the problem. She adds that a wider sales tax would generate roughly $500 million in revenue but it would not cover lost tax revenue. The problem is that the loss of revenue is so massive it would mean making major cuts to things like public safety and public education.

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David Waring

David Waring was the founder of LearnBonds.com and has been a major contributor to the extensive library of investing news and information available on the site. Until the launch of Learnbonds.com in late 2011 there was no single site on the internet catering exclusively to the individual bond investor. This was true even though more individuals own stocks than bonds. Learn Bonds was launched to fill that gap.

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