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Gov. Bruce Rauner has won relief from a group of banks, reducing the near term risk of the financially strapped state having to make a $150 million payout if the state’s bond rating continues to fall.

But the state is hardly out of the woods in mitigating the damage from a 2003 bond issue that has proven costly for taxpayers. That penalty still looms if Rauner fails to renew critical letters of credit that expire in November.  

Rod Blagojevich

When officials in former Gov. Rod Blagojevich’s administration prepared to sell $600 million in bonds, they were concerned that rising interest rates would eventually drive up repayment costs. To protect against interest rate spikes, they entered complicated financial contracts known as swaps.

With the financial collapse of 2008, however, that strategy began to backfire. 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 only made matters worse. Continued downgrades by major bond rating agencies can force a termination of the swaps, forcing the state to pay a penalty in the range of $150 million.

The Rauner administration announced on Oct. 4 that the banks had agreed to ease terms that allowed them to end the swaps, thereby lessening the likelihood of the state having to meet a big payout. Bloomberg News reported recently that Barclays, Bank of America, and JP Morgan Chase all pledged not to call the swaps unless the state’s bond rating deteriorated to junk status. Deutsche Bank—whose swap accounts for about $99 million of the potential fees—lowered the trigger even further to a step below junk.

Illinois’ debt is currently rated two notches above junk level by Moody’s and Standard & Poor’s.

“The Rauner administration has successfully negotiated better terms for Illinois’ taxpayers, which have reduced our financial exposure and increased our ability to direct the state’s limited resources to education and social services,” Rauner spokeswoman Catherine Kelly said.

However, letters of credit—bank guarantees of the safety of the investment—expire on November 27. An expiration of such letters of credit would trigger a termination of the swaps and require an accelerated repayment of the bonds that could cost as much as $1 billion, according to Grassroots Collaborative, a nonprofit that has followed the issue and advocates for social services for low and moderate income consumers.

Rauner’s statement said his Office of Management and Budget “has made negotiating with the providers of letters of credit a priority,” with the goal to renew or replace them prior to the November expiration. 

Saqib Bhatti

Yet bank letters of credit are increasingly expensive and hard to come by. Even if secured, the state’s borrowing costs would almost certainly increase from the current rate of 6.79 percent in interest and fees. “The governor is taking credit for averting a crisis that he hasn’t yet fixed,” said Saqib Bhatti, a policy analyst at liberal-leaning think tank Roosevelt Institute.

Bhatti said that Rauner could still follow the example of Chicago Mayor Rahm Emanuel, who paid $377 million in recent years to terminate city and Chicago Public School swap deals and refinance bonds. The governor could also still sue the banks or use the threat of litigation as leverage to get a better deal.

The governor’s announcement came roughly an hour before Grassroots Collaborative was to begin a press conference with educators and social service providers calling on Rauner to settle the problem so as not to divert funds from social services including education and programs for children, seniors and violence prevention.

The press conference was postponed, but the organization issued a statement asking the governor to disclose terms of the latest agreement. “Taxpayers deserve to know what the governor has negotiated and if it benefits them or big Wall Street banks like JP Morgan Chase,” said Executive Director Amisha Patel.