Illinois Beats Investor Drum Ahead of $1.3 Billion Sale

CHICAGO — Working to calm jitters over Illinois' tarnished name, the state's debt manager and finance team met with more than 100 investors over the last week seeking to tamp down yield penalties on a $1.3 billion general obligation sale scheduled for Wednesday.

Despite the efforts, the state is up against a volatile market that will see supply of more than $9 billion and a carryover of unsold balances from the previous week amid a sell-off that drove up overall yields.

The state paid about 141 basis points over the Municipal Market Data triple-A benchmark on the 10-year maturity in its April GO sale. Market participants said Monday they had seen early suggestions from the deal's underwriters of a 160 basis point spread on the 10-year. Some market participants said their trading desks were projecting spreads on the 10 year at between 175 to 200 basis points, but cautioned the market was too volatile to predict, especially given the size of the Illinois deal.

Some also suggested that the increase may well be due more to rising rates and a widening of credit spreads in general than any change in views about Illinois.

Illinois Director of Capital Markets John Sinsheimer and finance team members returned to Illinois Friday from a week-long investor roadshow during which they met with more than 100 institutional investors in Boston, New York City, Los Angeles, and San Francisco. They had meetings in Chicago Monday and then return to New York City. They stress the strong priority pledge GOs enjoy on state revenues and the state's large and diverse economy.

The state reiterated its position Monday that it won't join some other issuers in holding deals this week despite market forces that may aggravate investors' squeeze for more yield from the state due to recent downgrades over a lack of legislative action on pension reforms. The state's five funds are just 40% funded and burdened with $95 billion of unfunded liabilities.

Proceeds will help finance the state’s $31 billion capital program, including transportation projects, school buildings, and others to promote economic development and the reconstruction of a rail transit line in Chicago.

"These projects that are being funded through this bond issue are critical and the dividends they will pay back in shorter commutes for people, better rail service, and better schools are worth more than the cost of what the bond market will throw at us," Sinsheimer said.

Wells Fargo Securities, Siebert Brandford & Shank LLC, and Stifel Nicolaus & Co. Inc. are senior managers. Peralta Garcia Solutions is financial adviser and Mayer Brown LLP and Sanchez Daniels & Hoffman LLP. The paper matures serially through 2038 and may offer term bonds.

The state on Monday put out a structure wire and will seek preliminary pricing views Tuesday.

Some market participants have suggested that the state can use its higher borrowing costs to amplify pressure on lawmakers to act, but Sinsheimer said it's the need for funds that is driving the decision to go forward. He also countered that any delay risks a further increase in general market rates.

The state is considering holding a retail order period simultaneously with the institutional pricing and is in negotiations with insurers for some maturities.

The impasse on pension reform drove Fitch Ratings and Moody's Investors Service recently to knock ratings down one level to A-minus, and A3, respectively in early June. Standard & Poor's rates Illinois A-minus. All three assign a negative outlook. The ratings were affirmed ahead of this week's deal.

The state's $6 billion bill backlog and the looming partial expiration of the 2011 income tax hike in fiscal 2015 also concern both investors and analysts.

Several market participants said they expect the Illinois deal to garner attention because of the higher yields it will need to offer to get the paper placed. "Illinois' massive bond sale this week may thus present a solid opportunity for income buyers; investors should monitor pre-sale and early pricing data closely," Municipal Market Advisors recommended Monday in its weekly outlook.

MMA's Matt Fabian added that "spreads for everything are wider" so he anticipates the state's higher costs will be driven more by the market shift than "investor opinion about Illinois."

The state's payables, the looming tax rollback and pension reform are the issues Sinsheimer said investors question him most about. "Everybody understands the credit risks the state presents but they also understand the credit strengths and so they are looking seriously at the bond. It's going to be a function of the yield" offered by the state, he said.

Sinsheimer stresses advances on pension reform even after the spring legislative session ended deadlocked over two rival plans. Lawmakers agreed to Gov. Pat Quinn's call for a conference committee to forge a compromise and Quinn set a July 9th deadline for a deal. The committee holds its first public meeting Thursday.

"Pension reforms come first," Sinsheimer said, adding the discussion about extending the income tax must wait.

An extension of the temporary income tax hike is not a forgone conclusion, as many investors have speculated, he said.

"Pension reform gives us some flexibility," he said because of the decrease in annual payments that would result. Any immediate impact would be delayed, however, by an expected legal challenge.

The state stresses during its meetings with investors the strong structure of its GO pledge and its sovereign powers to raise revenues without referendum. The state highlights other  “underpinnings” of its credit including a legislative prohibition on restructuring debt to push off debt service for budget relief, and past legislative victories on retiree healthcare reforms and Medicaid. The state is unique in that it operates a dedicated account that funds debt service in advance by setting aside 1/12 of principal and 1/6 of interest every month for payments due in the next 12 months.

The state's last tax-exempt GO sale offered yields that ranged from 68 basis points to 145 basis points over the triple-A municipal benchmark with the spread on the 10-year at 141 basis points. Illinois captured a true interest cost of 3.92%. Friday, the MMD scale ended with the 10-year yield jumping 15 basis points to 2.63% and the 30-year yield spiked 18 basis points to 3.96%.

Sources said the state's final 25 year maturity was expected to pay 200 basis points on the Municipal Market Advisors 5% index. The spread on the state's 25-year maturity in its spring GO sale was 134 basis points over the MMA scale.

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