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Downgrades Won't Stop Illinois From Selling $1.25 Billion of GOs This Month

CHICAGO – Illinois will bring GO bonds to the market at the end of month, undeterred by recent downgrades.

“There are critical capital projects and they need funding. It’s too important to the future competitive stature and livability of the state,” capital markets director John Sinsheimer said Thursday after addressing a luncheon hosted by Chicago-based Women in Public Finance.

Illinois has set the last week of June to sell $1.25 billion of new-money under its battered general obligation credit and demand for project funding is too great to pull the sale even if negative headwinds from downgrades and an unsolved pension crisis drive up interest rates, he said.

“The return to the state of improving its infrastructure is worth the incremental increase in the cost of the bonds,” he added, citing two high profile projects in-line for funding -- the reconstruction of a downtown Chicago highway interchange and a Chicago Transit Authority light-rail line.

The GO sale comes after two downgrades that followed the General Assembly’s failure to enact pension reforms before adjourning its regular session May 31.

Fitch lowered the state one notch to A-minus and assigned a negative outlook. Moody’s downgraded the rating on $27 billion of GOs one level to A3 and also assigned a negative outlook.

The state pulled a GO sale in January after a Standard & Poor’s downgrade, before bringing the deal at an increased size to market in April.

Sinsheimer said the financial team will go on a roadshow to various parts of the country to conduct investor meetings. Siebert Brandford Shank & Co. LLC, Stifel Nicolaus & Co. Inc., and Wells Fargo Securities are co-bookrunners. Peralta Garcia Solutions is financial adviser.

Proceeds will provide funding for the state’s ongoing $31 billion capital program promoted by Gov. Pat Quinn as a means to spur economic growth, create jobs, and improve the state’s infrastructure.

 Standard & Poor’s will hold the state’s rating at A-minus with a negative outlook as its downgrade in January reflected analysts’ dim view that an overhaul would be achieved during the spring session

Illinois is the lowest rated state by Standard & Poor’s and Moody’s and Fitch rates it the same as California, however California carries a positive outlook. 

The deal will follow a $600 million refunding of sales-tax bonds the week of June 10. Sinsheimer is less concerned over negative headwinds on that issue given its high-grade ratings of AA-plus from Fitch Ratings and AAA from Standard & Poor’s due to strong coverage from the sales tax.

Moody’s offered an especially harsh assessment of the political gridlock blocking pension reform. Quinn called a special session for June 19 in an attempt to break the impasse over two rival plans backed by House and Senate Democratic leaders. Any plan will require at least a three-fifths vote to pass instead of the simple majority needed during the regular session.

The state is saddled with $95 billion of unfunded liabilities with its system just 40% funded and pension payments are rising annually with a $6 billion payment due from the state’s $35.4 billion fiscal 2014 general fund.

House Speaker Michael Madigan pushed through a package of direct benefit cuts and increases in the retirement age and employee contributions. Senate President John Cullerton sponsored an alternative plan that asks employees to accept cuts in exchange for preserving their retiree healthcare subsidies. The House plan offers double the savings but Senate Democrats believe the plan cuts too deeply into promised benefits and can’t withstand an expected legal challenge.

While the rating agencies have concentrated on the state’s pension inaction of late, Sinsheimer said his presentation to investors underscores the strong priority pledge afforded to GO debt service. He also highlights the state’s diverse and strong economy supported by Chicago, its central role as a transportation hub with a handful of freight lines intersecting here.

“We focus on the economic strengths of the state,” he told the gathering.  “We are a very vibrant critical part of the U.S. economy. My job is to make sure the investors have all the facts so they can a thoughtful decision.”

Sinsheimer also stresses Quinn’s successes since taking office in early 2010 after lawmakers forced predecessor Rod Blagojevich from office for corruption.  The state passed pension reforms for new employees, a Medicaid overhaul, a massive capital program, and enacted an income tax increase.

Sinsheimer portrayed the successes as evidence that there is a “political will to govern” even though those accomplishments have now been drowned out by pension gridlock. He said investors he speaks to understand the state’s credit strengths and that solutions are within reach, but he acknowledges their concerns over the impasse on pension reform and knows some will shed their holdings after the downgrades. “Some won’t invest because they don’t want the name in their portfolios,” he said.

Investors offer varying views as to the state’s overall profile, noting the weight of other strains on its foundation. They include the partial expiration of the income tax increase in fiscal 2015 and a $6 billion backlog in overdue bills expected at the close of fiscal 2013 this month.

Buy-side market participants consider the GO statute a key strength and some believe Illinois prices have bottomed out, if only because of demand across the market for higher yielding paper and trading levels that already reflect BBB penalties.

Some also expect at least temporary volatility in spreads following the downgrades, but it’s unclear where they might settle or how steep a penalty will be assessed in the sale later this month given day-today market fluctuations and other offerings that week. The spread on a 30-year Illinois GO bond widened over the last month from 130 basis points over the comparable top-rated municipal benchmark to 142 basis points on Thursday. 

“Investors are going to have to weigh the reality of the state’s credit quality and decide how the bonds’ performance fits into their overall strategy,” said Richard Ciccarone, chief research officer at McDonnell Investment Management LLC. “The state must step up and address” its problems. Standard & Poor’s on Thursday warned that the state is approaching a critical juncture within a year. “The ability of Illinois to affect change to revenues and spending programs is well established, so future credit direction will largely hinge on the willingness of policy makers to decisively address chronic budget and pension issues,” analysts wrote.

The state has enjoyed unfettered access to the market – albeit at a steep borrowing penalty – during its fiscal credit crisis due to the current market’s overall willingness to overlook some credit challenges. That could change if the market shifts before the state rights its pension system and other budgetary strains, Ciccarone cautioned.

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