CHICAGO -- The Illinois General Assembly has passed legislation expanding the state's moral obligation pledge after Standard & Poor's Corp. stopped rating new issues tied to the pledge because of a misunderstanding over what it encompasses, state officials said.
The agency discovered this summer that the state's pledge does not extend to replenishing debt service reserve funds. State officials say that caused Standard & Poor's to stop rating moral obligation issues -- an action that an agency official denied.
At any rate, two issues planned for the summer had to be canceled due to the lack of ratings, according to officials at the state authorities involved.
The new law expands the pledge to cover debt service reserve funds, according to David Wood, general counsel for the state's Bureau of the Budget, who added that Gov. Jim Edgar is expected to sign the bill as soon as it reaches his desk.
"I think this case was resolved fairly and amicably, and everyone came out fine," said Todd Whitestone, a managing director at the rating agency. "There was a problem, I'm not going to deny that."
The executive said, "there was definitely a breakdown in communications about what they had in place in Illinois.
"We wanted the moral obligation to be a direct fill-up of any debt service reserve fund once it was invaded," he said. In the language of the state's governing statutes, he said "it wasn't that clear."
What the pledge encompassed was clear to state officials, who had to convince the agency that the reserve fund was not covered, one state source said.
It took 19 years for the agency to discover that the state's pledge was not as extensive as those of other states. Since 1972, Standard & Poor's has been rating Illinois Housing Development Authority debt that carries the state's moral obligation. The agency has been rating other state moral obligation debt since 1989.
A moral obligation bond is not backed by the full faith and credit of the issuer, which has no legally enforceable obligation to pay.
Currently in Illinois, authorities that carry the pledge can ask the governor for principal and interest payments when necessary. The governor then asks the General Assembly to appropriate the payments, according to Mr. Wood.
Because the legislature could take a year or more to appropriate principal and interest payments, authorities during that time may have to rely on their reserve funds for the paymennts, according to Mr. Wood.
Under the new law, passed Oct. 24, an authority could ask for money to replenish the debt service reserve fund as well, in the event of a withdrawal from the fund, to bring it back to the level required in the bond indenture.
The governor would submit the monetary request to the General Assembly by no later than the end of the current state fiscal year.
Mr. Whitestone said that despite the confusion over the moral obligation pledge "there was no loss of credit quality out of all this," and that the legislation made the state's pledge "stronger, not weaker."
He said the problem was not related to the placement by the agency of about $7 billion of the state's general obligation, moral obligation, and other state debt on CreditWatch with negative implications last February. The agency downgraded about $4.4 billion of debt on Aug. 2.
"I know we had a deal in-house with a moral obligation, and we went through the language carefully and just realized it did not conform completely" with the criteria of Standard & Poor's, Mr. Whitestone said.
The agency had three Illinois moral obligation issues pending for ratings last summer. The first issue, according to John Reichert, an assistant vice president at the agency, was an $11 million issue by the Quad Cities Regional Economic Developmennt Authority in June.
Duane Olivier, executive director of the Quad Cities authority, said he was not aware of any problems with the moral obligation backing of the deal, which was rated A-plus by Standard & Poor's and was sold in a private placement in July.
Mr. Reichert said that it was after rating that deal that the agency decided it needed to see changes in the pledge.
The next two issues -- $6 million of bonds by the Illinois Rural Bond Bank and $8 million to $9 million of bonds by the Southwestern Illinois Development Authority -- were subsequently canceled because Standard & Poor's declined to rate them, according to officials at the authorities.
"Standard & Poor's called and said that until legislation is passed they had suspended rating any more moral obligation issues," said Don Norton, executive director of the bond bank. "They said they wanted [the law] clarified for both future and outstanding issues."
Mary Kane, executive director of the Southwestern Illinois authority, said she was surprised by the agency's action. "It came out of the blue, that's for sure," she said.
Mr. Whitestone contended that no ratings request was denied and that the issuers may have decided "not to press forward" when they became aware of the problem.
He said he was not aware of this type of misunderstanding happening before at Standard & Poor's. "This is the only moral obligation situation I've heard of like this," he said.
Mr. Wood said the new law would strengthen the state's moral obligation in terms of "clarifying exactly what it is."
In addition, Mr. Wood said the law also allows authorities to certify a funding need under the state's moral obligation pledge at any time, instead of by specific dates cited in the statutes.
It also makes the governor's approval of moral obligation bond issues consistent for all eight authorities. Currently, only five of the authorities need the governor's approval for debt issuance. Mr. Wood said the governor's office, as well as state economic development officials and outside financial consultants would be reviewing all proposed moral obligation bond issues.
Mr. Wood said the new law was "evidence that the state has a strong desire to facilitate the use of its moral obligation in an appropriate and fiscally responsible way that is comforting to the rating agencies and bondholders."
The authorities that carry the state's moral obligation pledge are the bond bank, with $6.7 million of outstanding debt; the Southwestern Illinois authority, with $63.1 million; the Quad Cities authority, with $11 million; and the housing development authority, with $2.4 billion.
The remaining authorities -- the Illinois Development Finance Authority, the Upper Illinois River Valley Authority, the Will-Kankakee Regional Development Authority, and the Tri-County River Valley Development Authority -- have not issued any moral obligation debt, according to the Bureau of the Budget.