Rauner Reprieve On Costly Credit Swap Solution May Have Political Timetable

Deal to spare the state potentially costly penalties expires the day after the next election for governor in 2018.

Explainer
Sun-Times

Gov. Bruce Rauner has pushed off an impending and potentially budget busting day of reckoning to resolve a toxic 2003 state bond deal—to the day after the fall 2018 election in which the Republican is expected to seek a second term.

The governor had been facing a November 27 deadline to renew letters of credit that back the safety of investing in the $600 million bond issue, a procedure fraught with unusual difficulty because of the state’s prolonged budget standoff and fiscal crisis. Expiration of the letters threatened to trigger a termination of bank agreements and require an accelerated repayment of the bonds that could cost as much as $1 billion.

But under a recently announced agreement, four banks will acquire and hold the debt until November 7, 2018. Interest and fees will be close to the current rate of 6.79 percent, according to a senior Rauner administration official who spoke on condition of anonymity.

“Given the state’s credit rating and financial condition, we got a good deal,” the official said.

That buys time to come up with alternative financing schemes to mitigate financial pain, but absent that the state could still find itself in a similar bind when the new agreement with banks expires on Nov. 7, 2018, according to a supplement to the state’s most recent bond offering document.

That date, coming one day after the next election for governor,  carries significance for a political leader who has often chastised opponents for putting off tough decisions.

In June 2015, Rauner criticized Mayor Rahm Emanuel’s pension reform proposal as a “kick-the-can-down-the-road approach.” And during budget negotiations in May, he called on lawmakers to stay focused, stay disciplined and “don’t kick the can.”

Saqib Bhatti, a policy analyst at the Roosevelt Institute, a  liberal-leaning think tank, said Rauner’s administration also now seems to be entering delay mode on resolving problems with the bond deal rather than confronting them directly. 

“They’re kicking the can down to the end of the governor’s term where it may not be his problem,” said Bhatti.

The senior administration official said the expiration coming a day after the 2018 election is merely a coincidence. Two years is standard for these types of deals. “We would have gone longer if we could get three or four years,” the official said.

The headaches caused by the bonds date back to a bad bet made more than a decade ago by then Gov. Rod Blagojevich. When officials in his Democratic administration prepared to sell the bonds they were concerned that rising interest rates would drive up repayment costs. To protect against interest rate spikes, they issued floating-rate bonds backed by complicated financial contracts known as swaps.

With the financial collapse of 2008 that strategy backfired. Rather than going up, interest rates plunged, effectively costing the state tens of millions of dollars more than it would have had to pay if it had issued fixed-rate bonds.

The state’s deteriorating financial condition made matters worse. Continued downgrades by major bond rating agencies threatened to force a termination of the swaps and subsequent penalty in the range of $150 million.

Early this month, Rauner aides announced they had accomplished a first step in easing the likelihood that the state would have to meet an outsized payout on the bonds. The administration said banks that hold the bond debt had agreed to lower rating thresholds that allowed them to end the swaps and force a payout. Illinois’ debt is currently rated two notches above junk level by Moody’s Investor Service and Standard & Poor’s.

But expiration of the letters of credit also threatened to trigger a termination of the swaps as well as an accelerated repayment schedule. Bank letters of credit are increasingly expensive and hard to come by.

Under the new agreement with four banks, bonds not paid, redeemed or remarketed by the November 7, 2018 expiration will be subject to the same accelerated repayment at a higher rate. Before then, however, the state could try to sell the bonds back into the market with a new and potentially less costly letter of credit if the state’s credit rating improves. If interest rates rise, which would be in the state’s favor, Illinois could terminate the swaps at a smaller penalty and refinance the bonds.

The Moody’s credit rating agency praised the deal on the letters of credit in a weekly outlook on October 17. “The agreement is positive for the state, which otherwise faced accelerated maturity of the debt,” the rating agency said.

State Rep. David Harris, (R-Mount Prospect) ranking member of the Revenue and Finance Committee, credited the administration for clearing the immediate hurdle. But he and others argue that the banks benefitted at the state’s expense and should make concessions. Whether they conceded ground won’t be disclosed until the deal closes next month.  

“The banks disadvantaged the state and should take a hit,” Harris said.

Community activists argue that fees paid to the banks divert funds from social services including education and programs for children, seniors and violence prevention. They have urged the state to litigate, or use the threat of a lawsuit to wrest concessions from the banks. A spokesman for the Grassroots Collaborative, a nonprofit that advocates for social services, said the group wants to make sure Rauner doesn’t sign away the right to litigate. That too won’t be disclosed until the deal closes.

 

About the Author
  • Judith Crown

    Judith Crown is a veteran business journalist and a regular BGA freelance contributor. She has worked for major news outlets including BusinessWeek Chicago and Crain’s Chicago Business.