CHICAGO - Illinois finance officials are hoping to convince lawmakers to approve a $16 billion general obligation pension bond issue during the current legislative session in order to move quickly should market conditions prove ripe for the financing, a top fiscal aide to Gov. Rod Blagojevich said Monday.
Legislative authorization would put the state "in a position to be ready" to act fast, John Filan, the state's chief operating officer, said during a panel discussion on international demand for taxable municipal paper at The Bond Buyer's Other Post-Employment Benefits conference in Chicago Monday.
Several aspects of the market mirror conditions that resulted in what was considered a remarkably favorable average borrowing rate of 5.05% when the state sold $10 billion of GO pension bonds in June 2003.
Taxable rates remain low and international interest is strong, which in turn can help lower borrowing costs, according to panelist Adam Stoll, a vice president with Goldman, Sachs & Co. That adds to a transaction's financial benefits that come from borrowing at a significantly lower rate than what is earned on the proceeds and lowering the interest being paid on the unfunded liability.
Panelists said pent-up demand amid a lack of supply for high-grade taxable municipal paper is boosting interest. European interest is the strongest, though Asian buyers have shown recent interest in short-term maturities in the 10-year range, while interest from Middle Eastern buyers is rising.
The higher-rated credits in at least the double-A category are the most appealing, as they require the least amount of capital be set aside by the European investor to protect against possible losses. Structural issues drive international investor demand, with buyers looking at individual maturities for both size and liquidity. The inclusion in deals also of some maturities issued in Euros also can help attract buyers, according to panelists. About 45% of Illinois' 2003 deal was sold overseas.
Buyers also prefer a straight forward GO credit, or one close to it, such as an annual appropriation pledge. "Any structure that resembles a revenue bond" is going to have a harder time, with more education of investors needed, said David Burke, managing director at Depfa Bank PLC.
While the Illinois plan still needs legislative approval, state officials are watching the market. Several questions remain, including whether demand exists for a deal of that size, Filan said. Under the proposed borrowing plan, the state would also restructure its amortization schedule, increasing its annual payments by nearly $300 million. The infusion of bond proceeds would boost the funded ratio to 75% and put the state on track to reach a 90% funded ratio by 2033, 12 years earlier than now anticipated.
"It's really a powerful opportunity," Filan said.
The infusion of cash from the state's $10 billion GO pension deal helped bring the funded ratio of the pension funds to a current level of 63% from 48%. The improvement trimmed about $500 million in annual interest costs off the state's annual payment and generated an estimated $43 billion in present-value savings over the amortization period.
The state came under fire from lawmakers, however, for using more than $2 billion of the proceeds to cover two years' worth of scheduled payments to the system. Illinois also later revised its amortization schedule to reflect the savings associated from the infusion of bond proceeds, capturing much of the savings up front in its near-term annual contributions. The state's payment in fiscal 2008 totaled $2.6 billion.
Those controversial maneuvers are absent from the proposed borrowing plan and instead the state would increase its annual contributions. While legislative response so far has been chilly, Filan said he has had favorable discussions with some lawmakers who recognize the need to stem the pension-payment drain on state coffers.
Illinois has not yet released its actuarial accrued accounting of its unfunded liability for other post-employment benefits as required under new accounting rules. One business group has estimated the liability for the state's retiree health care benefits at more than the unfunded pension liability, but Filan said the final number - which will soon be released - is much smaller. Sources have said the number will likely fall between $20 billion and $30 billion.
Filan views issuing debt to pre-fund the state's OPEB liability more skeptically, noting the legal and statutory distinctions between the pension and OPEB liabilities. Illinois considers the pension liability a "hard" obligation because pension benefits are guaranteed by the state constitution. Rating agencies have countered that position to some extent, as they believe pension obligations represent a soft liability while debt service is a hard liability with little flexibility.
State officials consider OPEBs more "soft" as they are governed by collective bargaining agreements that are subject to revision. The benefits can be negotiated, and costs brought down by increasing deductibles and premiums. The state also must weigh the trade-offs of funding its OPEBs. For example, if funds are diverted from construction projects to better fund the OPEB liability, Illinois would face increased inflationary construction costs.
"We are pretty much stuck with the pension" liability, Filan said. "There's a lot of moving parts. OPEB is a very different animal."
