Deal in Focus

Illinois, Under Siege, Turns to Big BAB Sale

CHICAGO — Fiscally beleaguered Illinois enters the market on Thursday with $1 billion of taxable general obligation Build America Bonds, its first use of the federal stimulus program as the state seeks to raise new-money proceeds for its $31 billion capital program.

Barclays Capital is the senior manager with BMO Capital Markets and Bank of America Merrill Lynch serving as co-seniors and four other broker-dealers rounding out the team as co-managers. A.C. Advisory Inc. is financial adviser, Katten Muchin Rosenman LLP is bond counsel and Holland & Knight LLP is underwriters counsel.

Officials were originally planning a sale closer to $750 million. The size was bumped up because of the state’s demand for cash to finance projects. Officials also wanted to capitalize on the interest rate savings offered under the BAB program, and “the banks said the market would take the paper,” said state debt manager John ­Sinsheimer.

The bonds are tentatively scheduled to mature serially between 2011 and 2022 with a term bond in 2035. The bonds will carry a make-whole call over a traditional municipal 10-year call.

“It’s what the market likes and the net savings are significant,” Sinsheimer said. The state will apply for the direct-pay interest subsidy.

All of the bonds will be issued as BABs. While many issuers are using a mixed structure — issuing BABs on the longer end where the savings are most prominent and tax-exempt on the shorter end — the legislation authorizing the state to issue BABs does not enable the state to use a mixed structure, Sinsheimer said.

Ahead of the sale, all three major rating agencies affirmed Illinois’ ratings, providing one dose of good news. The state’s credit has suffered several rounds of downgrades that have pushed it to the lower rung among states, just above ­California.

The downgrades have been due to the state’s deteriorating fiscal position marked by declining revenue collections and the size of its structural budget imbalance, which lawmakers have refused to address until after the February primary.

Fitch Ratings assigns an A rating to the state’s $22.4 billion of GOs and has the credit on negative watch. Moody’s Investors Service rates the state A2 and Standard & Poor’s rates it A-plus, both with negative outlooks.

“The negative outlook reflects Standard & Poor’s view that while Illinois has the capacity to restore budget balance due to the absence of tax limitations or stringent constitutional or legal requirements related to spending that we see in other states, its willingness to implement difficult and politically unpopular measures to restore budget balance is questionable,” analyst Robin Prunty wrote.

The deal marks the latest in a series of planned issues. The state earlier this month sold $3.5 billion of five-year GO notes to fund its current year’s pension payments. It also comes less than one week before Gov. Pat Quinn faces state Comptroller Dan Hynes in the Democratic primary race during which the fiscal crisis has taken center stage.

Market participants said Illinois will have to pay a premium for the negative fiscal news in recent independent reports, rating agency actions, and newspaper and magazine stories. However, Sinsheimer said the state has held an informational call for investors and he has not fielded questions over its ability to repay its debt.

“I am happy to talk to any investor, but I think they are comfortable that this is a GO. It’s backed by the full faith and credit of the state and statutorily debt service has a first claim on state dollars,” he said.

Quinn and Hynes have traded escalating barbs over the fiscal mess and each other’s abilities to get the state back on sound financial footing. The victor of the primary next week will face the Republican nominee in the November election.

Quinn last year pushed for a 50% income tax increase. Hynes has proposed shifting from a flat tax rate to a graduated one with an increase on top earners. The Republican candidates favor cutting spending over tax increases.

Most fiscal analysts believe a tax hike or cuts alone would not be sufficient to close the state’s mammoth budget gap.

“Even if the governor’s income tax plan is enacted early next calendar year, it will constitute only a partial solution to the state’s larger, structural problem,” Moody’s analysts wrote. The tax would have raised about $3 billion annually.

A new report from the Civic Federation of Chicago — a financial watchdog group — and its Illinois Fiscal Sustainability project warns that going into fiscal 2011 the state faces a combined deficit of $12.8 billion, a figure in line with other reports.

Based on its review of the state’s fiscal 2010 revenues and expenditures, the federation said the deficit in the $54 billion budget stands at about $5.7 billion.

Officials relied heavily on one-time revenues to balance the budget that won’t be available in the next fiscal year. They included borrowing to cover pension costs, pushing off bill payments, and the use of federal stimulus funds.

Illinois also faces an increased pension payment and added debt costs to begin repaying its pension issue, pushing the budget deficit up to $12.8 billion. It’s also unclear whether the state will accomplish a planned debt restructuring that is now on hold. It was supposed to create $560 million in savings.

The state confronts a backlog of $5 billion in bills and looming repayment of $2.25 billion in cash-flow notes before the end of the fiscal year, while revenue for the fiscal year to date continues to falter.

Corporate income taxes fell 16.3%, sales taxes are down 12.6%, and individual income taxes are down 7.6% over figures for the same time last year. The mammoth unfunded pension liability of $79 billion is another negative burden putting pressure on Quinn and lawmakers to take up reforms this year.

“The negative rating watch reflects the magnitude and persistent nature of the state’s fiscal problems and will be resolved after an assessment of the extent to which the state addresses its funding imbalances in the context of the legislative session that begins in February, and the development of a budget for fiscal year 2011,” Fitch wrote.

Analysts said Illinois’ strengths include its deep and diverse economy, above-average wealth levels, the strength of the Chicago metropolitan-area economy, its sovereign powers to raise taxes and revenue, and the ability with legislative approval to dip into non-general fund surpluses

Proceeds of the sale will finance various transportation and other capital projects in the $31 billion capital plan signed into law last year. The plan relies on federal, state and local funding. The state will pay for its $13 billion share primarily with borrowing.

Debt service is to be repaid through additional revenue expected from a series of taxes and fees. They include an increase in the vehicle title fee, an increase in the license plate fee, a new tax on sweet tea, candy, coffee and hygiene products, an increase in the tax on wine and spirits, expanding gambling to allow for the installation of video gaming terminals at some establishments, and funds from the state’s road fund.

A complaint filed over the summer contends that the package is built on illegal funding mechanisms, including an expansion of gaming that allegedly violates federal law and an unfair liquor tax hike that is higher on spirits than beer.

The lawsuit was filed by Rocky Wirtz, owner of the National Hockey League’s Chicago Blackhawks, on behalf of his liquor distribution company, Wirtz ­Beverage Illinois and state taxpayers.

Meanwhile, some local governments are opting against allowing their establishments to install such gaming terminals, raising questions over whether the actual revenue collections will meet projections.

Sinsheimer declined to comment on the challenges, stressing that the upcoming bond sale is backed by the full faith and credit of the state.

Officials expect to enter the market before the end of the fiscal year with additional new-money GO borrowing and additional cash-flow issuance.

The planned sale of $400 million in qualified school construction bonds is on hold due to the negative impact on market appetite for the tax-credit bonds, with several bills introduced in Congress that could block the stripping of the tax credit. The market is still awaiting stripping rules from the Treasury Department and the Internal Revenue Service.



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