Deal in Focus

Moody’s Lowers Illinois

CHICAGO — Illinois will competitively sell $155 of new-money Build Illinois sales-tax backed bonds tomorrow, the first in a series of deals worth more than $5 billion planned over the next few months as the state struggles with a budget deficit that drove yesterday’s rating downgrade from Moody’s Investors Service.

The size of the budget problems and political delays in addressing them, along with a further weakening in the state’s fiscal 2009 results, prompted the downgrade to A2 from A1 on $24 billion of state debt, including its general obligation and Build Illinois bonds. California is the only state rated lower at Baa1.

Fitch Ratings rates the state’s GOs A and its Build Illinois bonds AA while Standard & Poor’s rates the GOs AA-minus with a negative outlook and the Build Illinois bonds AAA.

The state will follow up the sale with a negotiated issue of Build Illinois bonds next Wednesday for $375 million, according to the state’s new debt manager, John Sinsheimer.

Cabrera Capital Markets LLC will senior manage the deal and Siebert Brandford Shank & Co. and Jefferies & Co. are co-seniors. Acacia Financial Group will be financial adviser.

Illinois has not issued new-money Build Illinois bonds since 2007. The program was established in 1985.

“This is a great credit backed by sales taxes with 23 times coverage,” Sinsehimer said.

Officials looked at issuing taxable Build America Bonds, but could not due to a technical issue in the program’s indenture.

In its review of the Build Illinois deal, Standard & Poor’s analyst Robin Prunty wrote: “The stable outlook reflects our expectation that state sales tax collections will continue to provide very strong debt service coverage. Despite recent decline in pledged revenues, we believe the extremely strong coverage insulates bondholders from this volatility.”

Illinois has $1.6 billion of outstanding under the program.

Fitch noted that the bonds have a first lien on the state’s share of its 6.25% sales tax, less 1.75% of the state’s share of total revenues that are pledged elsewhere. Sales taxes raised about $7.2 billion in fiscal 2009.

Sales tax revenue declined 5.6% in fiscal 2009 and are expected to further dip by 5.6% in fiscal 2010, although coverage remains very high.

In its next sale, slated for Jan. 7, Illinois will issue $3.5 billion of general obligation pension bonds. The state will use the proceeds to cover a portion of its payments owed to the pension system in fiscal 2010.

 JPMorgan, Loop Capital Markets LLC, and Goldman, Sachs & Co. are book-runners on the taxable deal and Mesirow Financial Inc. is a senior manager. Peralta Garcia Solutions is financial adviser.

In late January, the state will return to the market to tap its qualified school construction bond allocation from the federal government that provides a tax credit for investors. Illinois was awarded allocations of $244 million in 2009 and 2010.

“It’s a great opportunity to issue debt at or near a zero percent interest rate,” Sinsheimer said of the program.

Most issuers have had to add a supplemental coupon due to investor demand, adding some interest costs to the financing, although it remains far below a traditional tax-exempt rate.

Officials are contemplating a deal between $250 million and $500 million depending on spending needs. The funds would be doled out to local schools districts that apply to the state. William Blair & Co. would serve as the lead manager and Scott Balice Strategies is acting as financial adviser.

The state will sell $750 million of new-money GO debt in early February, issuing taxable bonds and seeking a direct-pay interest rate subsidy under the federal stimulus’ Build America Bond program for the first time with an estimated savings of about 70 basis points over a traditional tax-exempt transaction,

Sinsheimer said. The deal is in the early planning stages and an underwriting team has not yet been selected.

Sinsheimer declined to comment on the rating downgrade, but said he is not concerned over the market’s ability to digest the upcoming sales.

“These four transactions attract capital from different parts of the capital pool and we are confident all of them will be successful,” he said.

Plans to restructure up to $2 billion of GO and Build Illinois debt for near-term budgetary savings are on hold for the time being as the state works on structuring issues, Sinsheimer said.

The $54 billion 2010 budget signed by Gov. Pat Quinn wiped out a $12 billion combined fiscal 2009 and 2010 deficit with $2 billion in spending cuts and one-time measures that included the pension borrowing and debt restructuring, and pushing the payment of $3.8 billion of fiscal 2009 bills off to fiscal 2010.

The governor pushed for an income tax increase but was unable to reach agreement with lawmakers. Instead, he signed off on a budget that puts difficult decisions off until the 2010 legislative session, which follows the Democratic primary election in February in which Quinn will face state Comptroller Dan Hynes.

The two men traded barbs last week over Quinn’s proposal to issue $500 million of cash-flow certificates to help bring down a $3 billion backlog in bills. The comptroller and Treasurer Alexi Giannoulias must sign off on short-term issues under Illinois statutes. Hynes held a news conference last Friday to announce his rejection of Quinn’s plan, while Giannoulias has yet to sign off on it.

Moody’s said it is concerned over the state’s ability to address its fiscal problems with little time remaining before the fiscal year ends.

“We were anticipating some movement towards improving the state’s financial picture by October or November,” said analyst Edward Hampton. “The planned deferral of legislative action to address fiscal 2010 imbalances until at least February or March leaves little time in the fiscal year to take actions to materially reverse the trend of financial weakening.”

The state’s final audited fiscal 2009 results are also expected to show a weakened balance sheet. It closed out the year with $4 billion in accounts payable, up from $975 million a year earlier, and the mammoth unfunded pension liability is now estimated at $79 billion.

Moody’s retained a negative outlook on Illinois, reflecting the likelihood of ongoing structural budget deficits, growing negative year-end fund balances, strained operating fund liquidity, and mounting pressure from pension and retiree health benefits.

The state’s strengths include its sovereign powers, a diverse economy with higher than average wealth levels and lower economic volatility than most other states. The Build Illinois bonds offer strong coverage ratios, but the rating is capped at the GO level.

Moody’s lowered the state’s GO global scale rating to Aa2. It also dropped some Metropolitan Pier and Exposition Authority debt tied to the state’s credit to A3 and civic center program debt two notches to A3.

Illinois has been hit with a series of downgrades. Standard & Poor’s downgraded the state’s GOs in March and recently changed its outlook to negative, while Fitch in July downgraded the credit by two notches. Moody’s previously lowered the state’s rating in April and then in July put it on negative watch.

On the dispute over cash-flow issuance, Sinsheimer said the governor’s office hopes to reach an agreement with Hynes on a compromise plan.

Quinn wants to issue up to $1 billion of certificates in two issues, but the comptroller believes the state can’t afford the additional debt with repayment of $2.25 billion of notes issued earlier this year due to be repaid before the fiscal year ends next June.

Also this week, state agencies were asked to look at cutting as much as 14% of their budgets to offset a $900 million drop in income tax collections.

Budget officials released a statement blaming the downgrade on the state’s past mismanagement and the economy and said it underscores the need for officials to work together to come up with a solution.

“The administration has proposed budget cuts, borrowing, revenue increases, and has asked for help from the federal government. We need everyone to work together and compromise for the common good to come up with solutions to solve this budget crisis,” the statement said.

Hynes issued the following statement following the downgrade: “This report confirms what I’ve long said — Illinois state government’s habit of spending more money than it takes in is harming the state’s ability to rebound from the downturn in the economy, making it more difficult for businesses to thrive, for people to find and keep work and for this state to move forward. … It also confirms that undertaking additional short-term borrowing, when the state already owes $2.25 billion in short-term borrowing, is a bad idea.”



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