Illinois Bonds: A Turnaround Story with Rewarding Risks

The State of Illinois has long been synonymous with fiscal turmoil, earning the dubious distinction of having some of the lowest credit ratings among U.S. states. But a quiet transformation is underway. Over the past four years, the state has clawed its way back from near-default territory to the "A" credit tier, with all three major agencies now assigning it investment-grade ratings. For bond investors, this presents a compelling opportunity: a chance to profit from a state's turnaround while earning yields far above those of safer municipal issuances.

The Credit Risk: Progress, but Still Stressed

Illinois' general obligation (GO) bonds currently carry ratings of A3 (Moody's, positive outlook) and A- (S&P and Fitch, stable outlooks). These ratings reflect significant improvements since 2021, when the state faced a $17 billion unpaid bill backlog and pension liabilities that threatened to derail its finances. Key steps driving the recovery include:
- Paying down arrears: The $6.5 billion GO bond issuance in 2017 slashed the bill backlog to under $500 million by 2023.
- Balanced budgets: For the first time in decades, Illinois has maintained fiscal discipline, avoiding structural deficits.
- Pension reforms: The Pension Acceleration Bonds, which raised $1.8 billion to reduce unfunded liabilities, have stabilized long-term obligations.

Yet risks remain. Illinois' pension funding ratio still lags behind most states, and its tax structure—reliant on a volatile income stream—could struggle if the economy weakens. Additionally, neighboring Chicago's recent downgrade by S&P (to BBB from BBB+) highlights the geographic concentration of fiscal stress in the region.

Data Insight: Illinois' 5-year GO bonds currently yield ~4.2%, versus ~3.5% for California and ~3.8% for New Jersey. This spread reflects lingering concerns but also a premium for investors willing to bet on further stabilization.

The Yield Opportunity: High Returns for the Courageous

Illinois bonds are a prime example of the “risk-reward tradeoff” in municipal investing. While safer issuers like Texas or Virginia offer yields below 3%, Illinois' higher-risk status delivers a meaningful income advantage. For income-focused investors with a medium-term horizon (3–7 years), this could be a strategic play.

Consider the Pension Acceleration Bonds, which have maturities extending to 2047. These bonds, rated A3/A- by the agencies, offer yields of ~4.5% for 10-year maturities. That's ~100 basis points more than comparable New York bonds—and the state's improving credit trajectory could compress that spread over time.

Data Insight: Illinois' yields have narrowed from 5.5% in 2020 to ~4.2% today, as ratings improved. A further upgrade to “A+” could push yields lower, benefiting holders.

The Investment Thesis: Why Buy Now?

1. Valuation: Illinois bonds trade at a discount to their credit standing. With all agencies now in the “A” tier, the market may underprice the state's progress.
2. Outlook: Moody's positive outlook suggests further upgrades are possible if fiscal discipline holds. Even a stabilization in ratings could lock in gains.
3. Diversification: Munis are tax-advantaged, and Illinois bonds offer a way to bet on a turnaround story without exposure to corporate credit cycles.

Risks to Consider

• Economic downturn: A recession could strain state revenues, testing Illinois' ability to balance budgets.
• Chicago spillover: The city's fiscal woes could indirectly pressure state finances if aid requests grow.
• Rating volatility: While upgrades are likely, any misstep (e.g., a budget gap) could reverse momentum.

Final Take: A “Buy” with Caution

Illinois' bonds are not for the faint-hearted. But for investors who can stomach volatility and believe in the state's reforms, they offer a rare chance to capture high yields in a sector where safety often means skimpy returns. Focus on shorter-dated bonds (5–7 years) to limit duration risk, and avoid any issuance tied to Chicago or pension obligations without clear repayment plans.

In a world of 3% yields on “safe” munis, Illinois' 4.2% is a compelling bet—if you're ready to embrace a little fiscal history.

Disclaimer: Past performance does not guarantee future results. Consult a financial advisor before making investment decisions.