CHICAGO — Illinois will test for a range of investor appetites with its competitive sale of $300 million of sales-tax backed bonds on Tuesday by offering to accept both tax-exempt and taxable bids on the issue.
After a lull in borrowing this year following the issuance of $8.6 billion in nine deals last year, the state will sell three deals totaling about $1 billion before the end of the year. It will competitively sell the bonds next week along with a general obligation issue slated for later in the fall. It will finish the year with a negotiated GO sale. State statutes require a chunk of annual debt issuance be sold competitively.
Proceeds from all three sales will finance projects in the $31 billion capital budget. While Illinois’ GO ratings have slid due to its budget and liquidity woes and investors have demanded an interest rate penalty as a result, the sales tax bonds carry stronger ratings due to strong debt-service coverage ratios.
Mayer Brown LLP and Burke Burns & Pinelli Ltd. are co-bond counsel. Robert W. Baird & Co. is financial advisor.
Fitch Ratings assigns a AA-plus to the credit and has not yet released an updated review. Standard & Poor’s affirmed the bonds’ AAA rating Monday.
The state has $1.7 billion of outstanding senior-lien sales-tax backed bonds and $455 of junior-lien bonds that were sold last year. The new issue will sell under the senior lien. Illinois’ $31 billion of GOs are rated A1 by Moody’s Investors Service, A-plus by S&P and A by Fitch.
The state collected about $7.06 billion in sales taxes in fiscal 2011 that was available for repayment of the bonds. The credit claims a first priority pledge and lien on those revenues, which provided a debt service coverage ratio of 24 times.
The state’s offering statement gives bidders the option to submit tax-exempt or taxable bonds, though bidders must designate all of the bonds in one category. The award will go to the bidder that offers the lowest true interest cost. The bonds feature a 10-year call and final 25-year maturity.
The state decided to offer the option in response to market turmoil and fluctuating rates, widening credit spreads, and a reshaping of the municipal yield curve following the Federal Reserve’s Operation Twist announced last month that was designed to lower long-term borrowing rates, and a boost in supply. European turmoil also could help pique the interest of overseas buyers.
“I would argue that the market is not operating efficiently when you have tax-exempt rates that are higher than taxable rates,” state debt manager John Sinsheimer said Monday, citing the 2.17% yield on the 10-year Treasury compared to the 2.53% yield on the benchmark 10-year muni. The muni yield has risen 56 basis points above its record low on Sept. 23. In late September, the 10-year Treasury stood at 2.01% while the comparable muni yield was at 2.18%.
“We spent a good deal of time meeting with overseas investors last year. They know the state’s credit and like the state’s credit. These are highly rated bonds and there may be an opportunity for some banks to get attractive paper that they can market to their overseas network,” Sinsheimer said. “This may get a better reception in the taxable market or it may not. We will see. The goal is to achieve the lowest borrowing costs for the state.”
Some issuers in 2009 and 2010 accepted either tax-exempt or taxable bids under the Build America Bond program, but this may be a first since that program’s expiration last year.
The so-called Illinois penalty is imposed on most in-state borrowers and has ranged from 15 basis points to 50 basis points on recent deals, depending on an issuer’s own headline risks and market conditions. Spreads on Illinois paper to triple-A paper have narrowed significantly this year following the state’s adoption of an income tax increase.
The state’s sales tax bonds are insulated somewhat from the state’s slow economic recovery. “The ratings reflect what we view as Illinois’ extremely strong protections against dilution of coverage by additional debt and strong debt service coverage from the pledged sales tax revenues levied statewide,” wrote Standard & Poor’s analyst Robin Prunty.
The upcoming issues are the first to tap new qualified underwriters, financial advisers, and legal pools. The state has selected to use just one firm, Mayer Brown, as bond counsel along with a minority partner.
The number and aggressiveness of bids Tuesday will test Wall Street firms’ willingness to overlook the state’s recent adoption of a book-running pool with 20 firms. Many had privately complained about the scoring system and the rotation list was set through a public drawing in which most top broker-dealers did not make the top 10.
The state has defended the list, saying it sought to broaden its book-running list.