Closer Look: Credit trouble costs Illinois money
By CHRISTOPHER WILLS Associated Press September 16, 2012 6:28PM
SPRINGFIELD, Ill. — The state of Illinois is running into credit trouble, just like anyone else who pays bills late and owes lots of money.
Two major credit-rating agencies have lowered their ratings for Illinois this year. That generally means the state pays higher interest rates when it borrows money for road construction, school improvements and other public works.
Illinois has one of the lowest credit ratings of any state in the country, an embarrassing situation for a state with a huge economy and strengths in transportation, manufacturing and agriculture. Experts say those assets aren’t enough to overcome investors’ concerns about state leaders failing again and again to control government pension costs.
“It’s also a signal — if we needed another signal — about whether Illinois is a place you want to open or expand a business,” said Therese McGuire, a professor of management and strategy at Northwestern University.
A close look at the state’s shaky credit ratings suggests their impact may be strongest as a warning bell. The actual cost appears to be small compared to the roughly $34 billion in general funds the state will spend this year, but officials stand up and pay attention when the ratings go down.
Three major companies study businesses and governments that are selling bonds and then rate them as a guide for investors. Bonds issued by a new company with a questionable business plan would get a low rating because it might fail and never repay the debt. Bonds sold by the federal government and most states get top ratings because they’re virtually certain to pay off the debt.
But the rating agencies have some questions about that virtual certainty when it comes to Illinois.
They’ve lowered the state’s credit rating several times in recent years. Moody’s Investors Service did it again in January, and Standard & Poor’s Ratings Services took action last month. Fitch Ratings hasn’t changed Illinois’ status this year.
Forty-eight states get ratings that translate to “prime” or “excellent” investments. Illinois, along with California, is considered a medium-level investment — although at the top end of the medium category, if that’s any comfort.
Credit ratings affect the state’s pocketbook and, therefore, taxpayers’ pocketbooks. The lower the rating, the higher the interest rate a state must pay when it borrows money by selling bonds.
“The rating matters,” said John Sinsheimer, director of capital markets in Gov. Pat Quinn’s budget office. “If we save money on interest rates, then we can put more money into services.”
Still, Sinsheimer said he couldn’t provide an estimate of how much the lower ratings are costing taxpayers. The budget office doesn’t spend time comparing Illinois to other states and it doesn’t decide whether to issue bonds based on rates at any particular time, he said.
But financial analysts said that compared to top-rated states, Illinois is paying somewhere between 1.2 percent and 1.5 percent more in annual interest on long-term bonds.
That suggests an additional cost in the ballpark of $25 million to $30 million annually in the early years of a $2 billion bond issue. The amount would decline as the bonds are gradually paid off. That’s a lot of money but not enough to have a major effect on the state budget.
Richard Ciccarone, managing director at McDonnell Investment Management in Oak Brook, said the rates Illinois pays are higher than would be typical for other bonds with the same ratings. That means investors are even gloomier than the rating agencies about what will happen next in Illinois, he said.
Some institutional investors have rules that could bar them from buying Illinois bonds if ratings slip much more, experts said, and some conservative investors may have stopped already. But Ciccarone and Sinsheimer agreed the state isn’t close to the point where it would have trouble finding buyers.
The good news for Illinois is that interest rates are extremely low right now. Even paying more than other states, Illinois still gets rates that would be considered a good deal in other eras.
Illinois gets such low ratings primarily because officials haven’t fixed the massive pension problem and more budget turmoil lies ahead.
Illinois retirement systems face a gap of roughly $85 billion between current assets and what they’ll eventually pay out in pensions. That’s the largest gap in the nation. The state must contribute more and more to the retirement systems each year, leaving less money for everything else.
Moody’s expects the pension contribution to double in less than 20 years, to $10 billion.
The governor and legislators patch together a new budget each year, but even after an income tax increase they don’t have enough money to pay bills on time, reduce state debt and provide all the services people want. The ratings agencies see that situation and look ahead to 2015, when the temporary tax increase expires, and foresee big trouble.
Brian Battle, director of Trading at Performance Trust Capital Partners, said California pays far lower interest on bonds than Illinois despite having almost identical credit ratings. The difference is that investors believe California has a plan for solving its problems and more money to get it done.