(Adds comments from Teachers' Retirement System spokesman and a portfolio manager)
CHICAGO, Oct 12 (Reuters) - Ahead of the sale of $1.35 billion of debt on Thursday, Illinois issued an ominous warning to potential bond buyers that it may not have enough money to make its fiscal 2017 pension payments on time.
The nation's fifth-largest state, which is limping through its second consecutive year without a complete budget, said it is possible that its five retirement systems may not receive payments when due because the state's general fund may be low on cash.
"A failure by the state to meet its payment obligations may result in increased investment risk for bondholders," the state said in a supplement to its bond sale prospectus released late on Tuesday.
Illinois already has the lowest credit ratings among the 50 states. A budget impasse, along with a $111 billion unfunded pension liability and a growing pile of unpaid bills, have pounded Illinois' ratings into the low investment-grade level of triple-B.
The supplement said that without full and timely payments, the pension funds may have to sell assets to raise money to cover retirement benefits. That in turn reduces investment returns, driving up the unfunded liability. Illinois owes the pension funds $7.826 billion in fiscal 2017, which ends June 30.
"(State Comptroller Leslie Munger) is doing everything she can to make all the November pension payments," said Rich Carter, her spokesman, adding that October payments will go out on time.
A cash crunch forced Munger, who pays the state's bills, to skip a $560 million pension payment in November 2015. It was made up before the end of fiscal 2016.
A spokesman for Teachers' Retirement System, Illinois' biggest fund, said benefits and investment operations would not be affected by any payment delay.
Representatives of Governor Bruce Rauner and the four other retirement systems did not immediately respond to requests for comment.
Bank of America Merrill Lynch is scheduled to price Illinois' general obligation refunding bonds on Thursday.
The state is already paying a hefty price to sell its debt in the U.S. municipal bond market, where its so-called credit spread over Municipal Market Data's benchmark triple-A yield scale is 162 basis points for 10-year bonds. By comparison, California's spread is just 23 basis points.
"My gut tells me that in a world starved for yield there will be investors that hold their nose and jump in with both feet," said Nicholos Venditti, a Thornburg Investment Management portfolio manager, referring to Illinois' upcoming bond sale. (Reporting by Karen Pierog; Editing by Matthew Lewis)