CHICAGO – Municipal market participants threw cold water on a proposal pitched by an Illinois pension advocacy group to borrow more than $100 billion to pay down the state’s massive unfunded pension tab.

The proposal pitched by the State Universities Annuitants Association calls for Illinois to issue $107 billion of 27-year fixed-rate bonds this year to bring the five-fund state system up to a 90% funded ratio.

The state has $128.9 billion of unfunded liabilities and the retirement system is just 39.9% funded based on fiscal 2017 actuarial data. Based on the market value, the tab totals $129.1 billion for a funded ratio of 39.8%.

Howard Cure, director of municipal research at Evercore
Evercore's Howard Cure is among the market participants that don't see how a big pension bond proposal could fly in Illinois. Bloomberg News

The proposal calls for 38% of the bond allocations to be set aside by each fund for special investment funds for debt payments until 2045. The state’s annual cost to repay the debt was estimated at $8.5 billion by the group, which did not estimate interest rates on the taxable debt in the short fact sheet it issued. The group contends the plan would shave $103 billion off the state’s pension costs for the system through 2045 bringing it down to $238 billion.

“Illinois’ pension debt is crushing its state budget, squeezing more and more resources each year from public universities, schools, and other critical programs and services,” the fact sheet says. “Illinois seriously needs to consider refinancing plans for the pension debt” to protect constitutionally supported benefits, reduce the state’s long-term costs, and provide immediate budget relief.

Several market participants said it’s hard to take such a proposal seriously given the size of the proposed borrowing and the state’s battered credit.

“There is little chance for the state to place $107.42 billion in debt,” said Howard Cure, director of municipal bond research at Evercore Wealth Management LLC. “Pension bonds are always a gamble in that the state is betting its rates of return will exceed the interest rate on this taxable issue. Based on the state’s luck and the recent heights of the stock market, this seems like a particularly risky bet at this time.”

The state now has a total of $24.7 billion of outstanding general obligation debt.

Cure added it’s unlikely the state could maintain its barely investment grade rating with such a hike in its debt levels. Unlike pension related payments, debt service on bonds can’t be pushed off, leaving the state with little fiscal flexibility.

“Illinois needs good ideas; this isn’t one of them,” said Matt Fabian, partner at Municipal Market Analytics.

A buyside analyst said many investors still interested in Illinois paper may have come close to their exposure targets so he can’t envision the state finding a market for such a deal even among those chasing yield. The source also questioned whether the association had applied reasonable borrowing rates to its projections.

The 10-year yield on the state’s $4.5 billion GO sale late last year landed at a 184 bp spread to the Municipal Market Data’s AAA benchmark. The spread is currently at 185bp and the average over the last 12 months is 206bp, said MMD municipal strategist Dan Berger.

“There is a reason almost nobody that is concerned with either government finance best practices or protecting taxpayers recommends using POBs unless it is part of a holistic pension funding solution,” the buyside analyst said.

The head of the House Personnel and Pensions Committee, State Rep. Robert Martwick, D-Chicago, said he believes the idea is worth exploring despite hurdles. He intends to hold a hearing on the proposal after lawmakers return to the state capital next week, according to a story published this week in the Springfield Journal-Register.

The plan is among a series of ideas that have been under consideration to rein in the state’s pension burden. That burden is primary factor – along with the state’s budget impasse that ended in July – behind the state’s fall to near junk status. The Illinois Supreme Court ruled in 2015 that benefits are constitutionally protected so the state is severely limited in what actions it can take.

The state borrowed $10 billion of taxable general obligation bonds in 2003 to bring down the liability. The play on arbitrage that requires the investment of proceeds earn more than interest paid on the bonds has so far worked in the state’s favor.

Other proposals include one promoted by Senate President John Cullerton, D-Chicago, that asks employees to accept cost of living adjustment cuts in exchange for preserving the ability for future pay increases to count toward pensionable salaries. Unions have threatened a constitutional challenge.

The Center for Tax and Budget Accountability has long promoted a re-amortization of the backloaded 50-year pension payment schedule reducing the funded ratio goal to around 80% from 90%. Gov. Bruce Rauner has promoted in some business speeches the idea of seeking some form of congressional approval to cut the state’s pension burden through the court system but his administration has declined to elaborate.

Under the current funding schedule established by lawmakers in 1995, the state is required to make contributions required to be sufficient, when added to employee contributions, investment income, and other income, to bring the total assets of the systems to 90% of the actuarial liabilities by 2045.

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