Thoughts on Illinois and the municipal bond market

In the midst of a three year budget impasse, the State of Illinois hit another milestone yesterday. The State was downgraded to the lowest possible investment grade rating and remains on negative watch with an S&P/Moodys credit rating of BBB-/Baa3. To put this into perspective, no US State has ever been rated below investment grade.

By passing May 31st without a budget in place, the task of approving a budget has become even more difficult. Now requiring a three- fifths majority vote to pass a budget, Illinois which already faces billions in unpaid bills, severely underfunded pensions, and complete political gridlock has the unenviable task of digging themselves out of an even deeper hole.

The outlook for the State is grim as their constitution prohibits a number of already attempted fixes to some of their largest issues, i.e. pensions, in addition to the fact that the State is prohibited from filing for bankruptcy. While the severity of this situation is unique to Illinois, it bears watching as it plays out and what effects it could have on other states in the U.S.

We have been closely watching the public pension fund issues our country faces. The imbalances that exist between what has been promised and what has been set aside to fund those promises remain significant. This environment makes credit research and a focus on quality extremely important when structuring a municipal bond portfolio. We do not hold any State of Illinois debt and will continue to monitor the development of this story to understand its impact on the credits we do hold. Our emphasis on quality and balance should continue to set us up for success in an increasingly volatile municipal bond market going forward.

 

Ryan Omensetter - Assistant Portfolio Manager, DT Investment Partners

 

Note: DT Investment Partners’ commentary discusses general developments, financial events in the news and broad investment principles. It is provided for information purposes only. The material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Investments in various asset classes entail different investment risks. For example, small cap equities tend to be more volatile than large or mid-cap equities. International equities and emerging markets have exposure to currency fluctuations, foreign taxes, political instability and the possibility for illiquid markets. Fixed income investments involve interest rate and credit risks among others. Real estate investing includes risks such as declines in value of real estate, changing economic conditions, tax laws or property taxes. Commodities’ investing is highly volatile and subject to changing economic conditions and the vagaries of speculators among other risks. Further, diversification and strategic or tactical allocation do not assure profit or protect against loss in declining markets. Index performance returns do not reflect any management fees, transaction costs or expenses. One cannot invest directly in an index. Past performance does not guarantee future results.