Illinois makes moves on deficit with $711M of cuts, $2B MLF borrowing

Bonds

Illinois began chipping away at a nearly $4 billion budget hole this week by slashing $711 million in spending and the expected closing this week of a $2 billion loan through the Federal Reserve’s Municipal Liquidity Facility.

Illinois Gov. J.B. Pritzker announced the fiscal 2021 cuts Tuesday. He also called on lawmakers to lay out plans to further address the gap that’s due to the COVID-19 pandemic’s tax revenue blows and structural cost demands.

“This gets us part of the way toward addressing the budget deficit,” Pritzker said during his daily COVID-19 briefing. “For additional and more permanent balancing of our budgets going forward I will work with the legislature but make no mistake legislative action and engagement is required.”

“This gets us part of the way toward addressing the budget deficit,” Illinois Gov. J.B. Pritzker said Tuesday of $711 million in cuts.

Pritzker attributes about half of the current hole to the pandemic and half to structural strains. He had been banking on scrapping the current flat income tax for a progressive rate structure to generate at least $3 billion more in annual revenue but voters rejected a constitutional amendment question on the November ballot.

To address the pandemic hole, the state is borrowing from the Federal Reserve’s Municipal Liquidity Facility. The terms were set for the three-year borrowing with the closing expected later this week. Pritzker had previously set the borrowing level at $2 billion. The state already borrowed $1.2 billion to deal with a $2.7 billion fiscal 2020 pandemic hole and will repay the first borrowing by June 30.

“As announced previously, Illinois is going through the Municipal Liquidity Facility borrowing process. We have not completed the borrowing, but are working through the final details with closing by the end of the week. The three-year notes will have a borrowing rate of 3.42%,” said Carol Knowles, spokeswoman for the Governor’s Office of Management and Budget.

The rate is based on MLF pricing that uses a fixed interest rate based on a comparable maturity overnight index swap rate plus a spread based on a borrower’s ratings. Illinois’ spread based on its ratings that are one notch above junk is 3.30%. The program expires at the end of the month.

The state’s three-year bond is currently set at 1.99%, a 183 basis point spread to the Municipal Market Data’s AAA benchmark so the 3.42% represents a steep penalty. Despite the high rate, market participants have said the state’s decision to authorize use of the MLF was a smart move given its market rates fluctuate and its access alone could contribute to improved overall trading levels.

The state’s spreads have zig-zagged throughout the pandemic depending on negative headlines over its deficits, threats to its investment grade rating, planned borrowings, and the market’s appetite for higher-yielding paper.

The current three-year spread of 183 basis points is improved from 228 basis points at the start of December, 208 basis points at the start of November, 253 basis points at the start of October, and 221 basis points at the start of August and September.

The state will use the $2 billion to pay down a backlog of bills that stood Tuesday at $7.95 billion. Comptroller Susana Mendoza will use the funds to leverage an additional $1 billion in federal dollars for Medicaid bills.

The state’s $43 billion general fund budget included authority to borrow up to $5 billion through the MLF but the administration settled on the $2 billion level. Mendoza said without the assurance of future federal aid for local and state governments which remains one of the most controversial pieces of ongoing congressional negotiations she wouldn’t support tapping more of the statutory authority.

The state will use any potential federal relief and revenue growth to repay the GO-backed borrowing through the MLF. Fitch Ratings, Moody’s Investors Service, and S&P Global Ratings all assign a negative outlook so the state must tread cautiously in borrowing without a firm repayment plan identified.

Illinois was the first eligible borrower to take advantage of the $500 billion Municipal Liquidity Facility program in early June when it sold $1.2 billion of one-year certificates to help cover a $2.7 billion fiscal 2020 revenue shortfall.

The state paid an interest rate of 3.82% on the June certificates. The Federal Reserve has since lowered the spread by 50 basis points.

Illinois and the New York’s Metropolitan Transportation Authority have been the only participants so far. Market participants credit the program with helping to stabilize the market after a tumultuous March. The MTA last week borrowed its remaining $2.9 billion of authority with the issuance of payroll mobility tax bond-anticipation notes with a 1.33% coupon for those maturing in 2023.

Pritzker didn’t say how much more cutting was needed or whether other tax hikes would be sought and used the occasion to attack the GOP opposition to the income tax amendment. “I’m waiting on the General Assembly’s engagement in this” Pritzker said of additional cutting. “In particular to the Republicans because they have a special responsibility here, having worked so hard to defeat the ‘Fair Tax’ to step up to the plate, tell us how they’re going to balance the budget.”

GOP Senate Republican Leader-Designate Dan McConchie, R-Hawthorn Woods, countered that “the governor can blame others all he wants for the state’s financial mess, but the fact of the matter is this is a bed of his own making” by not reining in fiscal 2021 spending ahead of the budget passage last May. Pritzker is a Democrat and Democrats hold a legislative majority.

The spending cuts announced Tuesday include a hiring freeze, grant reductions, and operational savings in corrections, healthcare and human services, economic development, culture, the environment, and government services. Union negotiations are also underway to identify $75 million of personnel cost adjustments, which could include furlough days.

Prizker had previously asked state agencies to identify 5% in cuts in the current budget and potential 10% cuts in fiscal 2022. State legislative leaders cancelled planned veto sessions for this year. That puts any agreed-to action off until at least early January when a lame-duck session is expected before the new General Assembly is sworn in later in the month.

Illinois’ forecast warned of deficits between $4.2 billion and $4.8 billion annually over the next five years unless the fiscal 2021 gap is closed with structural fixes. That red ink would be piled on to the existing backlog, causing it to surge.

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