Illinois deal trims state's spread penalties

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CHICAGO — Illinois fared better Wednesday in its latest primary market outing than its last as investors rewarded the state passing a bipartisan, on-time fiscal 2019 budget that eased the threat of a rating cut to junk.

The state saw a 175 basis point spread to the AAA benchmark on the 10-year maturities in the $966 million general obligation refunding issue JPMorgan priced Wednesday. The BBB spreads — where the state's paper is rated — are back under 100 bp after going up for the state's previous GO sale in April.

The yields marked an improvement from the $500 million April sale when the state’s 10-year landed at a 200 bp spread.

But Wednesday's yields also landed at levels over recent secondary trading on most maturities. The 10-year recently traded at a 163 bp spread.

The 10-year in a November 2017 sale landed at a 170 bp spread as that deal benefited from the then recent breakthrough of passing a state budget after two years without one.

“It was talked about at [price] levels cheaper than where it had been trading,” and that helped gauge interest and build an order book, said Lyle Fitterer, head of tax-exempt fixed income at Wells Capital Management.

Some maturities were five to seven times oversubscribed allowing the underwriters to shave spreads. “I think they did a nice job distributing that amount of debt,” Fitterer said.

The deal’s size was raised from an originally planned $920 million.

The market had demanded wider yield penalties in April as investors fretted over the possibility that lawmakers would deadlock on a budget, putting the state at risk of a downgrade to junk.

Gov. Bruce Rauner and his fellow Republicans and the General Assembly’s Democratic majorities agreed to a budget plan by an end of May deadline. Rating agencies signaled that despite its flaws it would likely preserve the state’s investment grade ratings through the November election cycle and Moody’s Investors Service in July moved its outlook on Illinois to stable from negative.

The deal offered maturities from 2020 to 2033.

The 10-year landed at a 4.19% yield, a 93 bp spread to the BBB benchmark. That was six basis points better than the preliminary pricing.

The long bond maturing in 2033 in the Wednesday sale settled in repricing at 4.34%, a 163 bp spread to the AAA and a 78 bp spread to the BBB, and seven bp below preliminary pricing. The state’s 2033 maturities had previously been set at a 150 bp spread by MMD based on secondary trades. The 2033 maturity in the April sale sold at a 185 bp spread.

“That is what it costs to move $968 million of bonds and clear the market” for the weakest-rated state, said Brian Battle, director of trading at Performance Trust Capital Partners, of the original yields offered at above trading levels.

Battle and Fitterer attributed the demand to the top yields, the improved outlook, and market conditions with demand strong for both supply and high-yielding paper -- especially given the flatness of the yield curve with not much of a yield boost between a single-A and AAA.

“The deal was oversubscribed but it wasn’t knocked out of the park,” said one trader about the appetite for the Prairie State’s paper. “It was well received, however, in what ended up being a flat market. I think in general, a lot of people are away from desks and that I think is what stopped it from being a potential blow-out.”

The deal’s true interest cost landed at 4.19% and the state received bids from 87 institutional investors with more than $4.1 billion in orders, for a 4.3 times subscription on the bonds, according to a statement from the Rauner administration.

“We are very pleased with the strong investor response to today’s bond sale. By refunding the $600 million in variable-rate debt, the state eliminates its highest-cost debt and replaces it with traditional fixed-rate bonds carrying a much lower overall rate of interest,” state budget director Hans Zigmund said in a statement. “By refunding other outstanding bonds with higher fixed rates as part of the same bond sale, we maximized savings and minimized the costs of the sale. Taxpayers will realize these savings for years to come.”

The deal sheds the only floating-rate paper exposure in Illinois' $29.7 billion general obligation debt portfolio and allows it to cancel related interest rate swap contracts negatively valued at $74 million as of Aug. 1, according to the offering document. The state also current refunded other debt for savings.

The Series A that refunded the floaters and included the cost of terminating the swaps generated $93.6 million of total savings, or 12.15 % net present-value savings. Proceeds from the B series to refund other GOs resulted in $33.6 million, or 5.89%, of present-value savings.

Illinois adopted an on-time, full-year budget in May but it leaves the state with a $1.2 billion structural deficit heading into fiscal 2020 that could get worse if some revenues counted on this year don’t come to fruition or the state is required to cover all of a $400 million overdue bill for pay raises.

The state is saddled with $129 billion of unfunded liabilities and a bill backlog reported at $7.8 billion Wednesday. The budget benefits from more than $4.5 billion in increased income tax revenue following the tax hike adopted with the fiscal 2018 budget.

JPMorgan ran the books with Bank of America Merrill Lynch, Loop Capital Markets, Siebert Cisneros Shank & Co. and PNC Capital Markets as co-senior managers. Columbia Capital Management LLC is advisor and Swap Financial Group is swap advisor. Chapman and Cutler LLP and Burke, Burns & Pinelli Ltd is bond counsel.

— Chip Barnett and Aaron Weitzman contributed to this story.

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