CHICAGO — Top Illinois finance officials are on the road this week selling institutional investors on the tidy structure of the state’s upcoming $1.5 billion unemployment bond issue and emphasizing that it is highly insulated from the state’s well-publicized liquidity and budget struggles.
The state’s director of capital markets, John Sinsheimer, and the chief financial officer of the Illinois Department of Employment Security, Jon Gingrich, are hitting eight cities with members of the finance team on the tax-exempt deal that is set to price next week.
Illinois is the latest state borrowing in the bond market to repay loans from the federal government taken out to fund unemployment insurance benefit payments sapped by the most recent recession and ongoing high unemployment numbers.
The issuer is the Illinois IDES. The unemployment insurance fund building receipts revenue bonds will sell in three tranches — Series A is $778 million, Series B is $543 million, and Series C is $172 million.
“It’s an independent credit,” Sinsheimer said. “One of the keys to the structure is that the funding stream is well-established and the funds do not flow to the state Treasury. They are under the control of IDES and they provide for very strong debt service coverage.” The coverage ratio is 1.52 times and surplus payments will go to retire the bonds early.
JPMorgan, Citi, Loop Capital Markets LLC, and Bank of America Merrill Lynch are the co-book-runners. Another 10 firms round out the underwriting syndicate.
Mayer Brown LLP and Pugh Jones & Johnson PC are co-bond counsel. Winston & Strawn LLP and the Tyson Law Group LLC are co-underwriters counsel. Acacia Financial Group is advising on the transaction.
Ahead of the sale, Fitch Ratings assigned a AA-plus and Standard & Poor’s a AA. The outlook from both is stable. The state did not ask Moody’s Investors Service to review the issue.
The sale is set for July 18. The finance team has not yet decided whether to hold a retail order period a day before the pricing.
Illinois has paid steep penalties over the last few years to borrow — and some more conservative buyers have taken a pass on Illinois paper — due to its liquidity woes, budget deficits and mounting pension liabilities that have driven several rounds of downgrades. Sinsheimer said the finance team was receiving positive reviews from institutions on the structure and was seeing interest from new buyers.
The Series A bonds mature between 2013 and 2017 and are not callable. The B bonds mature between 2017 and 2020 with optional early redemptions between 2014 and 2017. The C bonds carry a 2021 maturity, but are structured as supersinkers, with an anticipated redemption date as soon as 2014. The bonds do not feature a debt service reserve. The structure was modeled slightly after the Texas Workforce Commission’s $1.7 billion issue in 2010.
Investors said the deal will benefit from fortuitous market timing, with buyers flush with cash. But it likely still faces some penalty, since the bonds will still count towards a fund’s holdings of Illinois paper, and the state has been an abundant issuer in recent years.
“There is so much cash out there,” said Thomas Spalding, senior investment officer at Nuveen Investments Inc. “But the deal still has the state name and buyers are still going to be limited.” He said the state likely would have to pay 25 basis points over a similar credit.
Steve McLaughlin, an executive director at R Seelaus & Co., said, “The deal should be well received based on the credit and the structure, and a lot of market interest in the short end, especially for super sinkers.” The credit strength should prove helpful if the state goes with a retail order period, given retail’s greater skittishness over headline risks.
The bonds are secured by a first lien on so-called fund building receipts, which come from state employer contributions to the unemployment insurance trust fund. The fund building rate is set at 0.55% for the life of the bonds on a statutorily determined wage base.
Illinois last sold unemployment trust bonds in 2004 in a $750 million issue. It paid off those bonds two years early.
“We have taken this route before,” Gingrich said, calling the repayment stream reliable and the borrowing plan the best option “for use when we are in a difficult position.”
Standard & Poor’s analyst Robin Prunty said: “We base the AA rating on what we view as Illinois’ diverse statewide economy, healthy projected debt service coverage, established history of strong revenue collections since 1988, a closed flow of funds with the retention of revenues expected to pay debt service in advance of stated maturity, and strong bond and statutory provisions.”
The fund building rate charted to employers generated $295 million in 2011 and, with enacted adjustments to the rate and wage base, is expected to raise $363 million this year.
The pledged revenues are held in a separate and distinct account from various state funds and benefit from an irrevocable and continuing appropriation of receipts. Illinois has a collection rate of unemployment taxes from employers of 98%.
Challenges to the credit include the economically sensitive nature of the pledged revenues, the fixed rate in place to secure the bonds that would require a legislative action to change and the lack of a debt service reserve.
The credit benefits from a borrowing cap that requires at least 75% of the current bonds to be retired and coverage to remain at 1.5 times.
Fitch noted that the state’s economy is a credit strength, but its recovery has been slow. The state’s unemployment rate remained slightly above the national rate at 8.6% in May.
Sinsheimer said the state achieved the rating level it sought, as going after higher credit marks would have required a debt service reserve and other features such as the ability to raise employer contributions without legislative action.
“We did not think the spread between a double-A and triple-A was worth what it would take to get there,” he said.
Michigan last month sold $3.3 billion of bonds to defease short-term debt issued in late December to pay off its federal unemployment liability. Colorado last month sold $625 million. Texas and Idaho have also issued bonds for their liabilities. Other states are eyeing the option.
Fitch is holding a teleconference on the subject Wednesday. It believes issuance will continue as states seek to lower their interest rates and stabilize their funds.
Federal loans that supported state unemployment trust funds were previously interest-free due to a stimulus act provision that expired early last year; the current federal interest rate is set at nearly 3%, down from 4.1% last year, making the bond market an attractive option. By repaying the government before the end of September, Illinois will avoid the interest rate penalty.
“If structures and provisions remain consistent with bonds issued to date, we would expect them to retain minimal risks for bondholders,” Fitch analysts Laura Porter and Rob Rowan said in a report last month. “All of the bonds are ultimately backed by employer payroll taxes with very strong collection history. Most structures have an ongoing mechanism to adjust rates to maintain debt service coverage and include a variety of features to enhance liquidity.”
Currently, 22 states have outstanding loans from the federal unemployment account totaling more than $29 billion.
Gov. Pat Quinn signed legislation paving the way for the transaction last year. Supporters contend it’s the most affordable means of restoring the trust fund to solvency. The legislation also included business perks to promote job creation.
The borrowing plans and legislative changes are expected to save $240 million in interest as officials anticipate an all-in borrowing rate of under 3%. It leaves existing benefits intact and staves off increased business taxes.
The funding changes are expected to save businesses at least $400 million through 2019 by eliminating penalty taxes that further federal borrowing would trigger. It also would provide a 16% unemployment insurance tax reduction for companies that did not lay off workers during the recession.
