The State of the State – Revisited
In May 2017, Gurtin Municipal Bond Management presented “Illinois and Chicago Credit Update,” which was an insider’s look at the state of the municipal bond market in Illinois and Chicago. It was an informative but sobering look at the many financial challenges faced by Illinois and Chicago. Just recently, Gurtin returned with “Updates for the State of Illinois and Chicago,” which took a fresh look at the financial health of the state and city. Unfortunately, even though two-and-a-half years had passed, little had changed as both Illinois and Chicago continue to face ongoing tremendous financial challenges. Here are some of the highlights (or lowlights) from Gurtin’s presentation:
State of Illinois
When Gurtin presented in May 2017, Illinois was in the middle of a budget impasse. The state had gone two fiscal years without a budget and was about to enter a third. Unpaid bills had risen to $15 billion and the rating agencies were circling, threatening to downgrade Illinois’ credit rating to below investment grade. At the end of June, the state legislature passed a budget that was vetoed by then Governor Rauner. The Illinois Senate and House overrode the veto and Illinois finally had its first working budget in almost three years.
While the breaking of the budget impasse avoided a potential financial calamity, Illinois was by no means out of the woods. Certain elements of the budget such as the permanency of higher tax rates and a plan to issue bonds to cover unpaid bills were helpful in shoring some things up, yet nothing was done to address the longer-term financial issues such as the state’s $130 billion in unfunded future pension liabilities.
Fast forward two-and-a-half years. Illinois now has a new governor and a new push to pass a progressive income tax. However, this measure would require voter approval to become law. And, even if it does, higher taxes alone may not solve the longer-term pension issues. Making any changes to the pension system also requires a constitutional amendment. Governor Pritzker has said that changing the existing system is a non-starter.
So, the financial situation in Illinois is as sobering as before. However, there are some slightly encouraging factors. The backlog of unpaid bills has fallen, pension funding ratios are stabilizing, and the pension systems have built in more realistic assumed rates of return which should help more closely model reality. Nevertheless, those liabilities are still astronomically high and the migration of people out of Illinois won’t help the state’s revenue base going forward.
City of Chicago
Chicago continues to face its own financial challenges and like Illinois, Chicago’s fiscal situation has not markedly improved since 2017. Like with the state, the city is burdened with massive unfunded pension liabilities. And, most of the tax revenue Chicago generates goes towards servicing existing debt and annual pension payments.
In the past, Chicago used short-term debt to cover financial shortfalls. Then, the city moved to leasing/privatizing valuable assets such as the Chicago Skyway and parking meters to close the gap. Unfortunately, the cash generated from these transactions was quickly spent with little to no impact on the longer-term problems. While the state has more financial flexibility and tools at their disposal to deal with its financial problems, Chicago’s options are more limited. The solution will likely be higher property and sales taxes and new sources of revenue such as casinos.
What does this mean for you?
Given the gloomy outlook for Illinois and Chicago, are their bonds worth buying? In Gurtin’s opinion, the answer is no – at least for general obligation bonds of the two entities. However, Gurtin’s extensive credit research extends to over 70 municipalities in just Illinois alone. Across those municipalities, there are many attractive bonds that Gurtin does own on your behalf. And this does not account for Gurtin’s nationwide reach. Gurtin’s credit research covers just about every corner of the municipal bond market.
In the end, the biggest takeaway is that the municipal bond market is incredibly complex and not something investors should try to navigate on their own. It is critical to have an experienced bond manager like Gurtin at the helm to steer your portfolio through uncertain and sometimes rough waters.
If you would like the slides from the presentation, please contact your wealth management team.
As a member of the Investment Committee, Matt is instrumental in developing BDF’s overall investment strategy. Matt received his Bachelor of Science in Economics with concentrations in accounting and finance from the Wharton School of the University of Pennsylvania and his MBA in finance and strategic management from the University of Chicago Booth School of Business.