Illinois plays waiting game on cash flow issue amid coronavirus-widened spreads
Illinois backed away from a Wednesday pricing of $1.2 billion in one-year general obligation certificates, moving the competitive sale to the day-to-day calendar as fiscal headwinds threaten to impose steep yield penalties.
“They need the money but at what price?” said Brian Battle, director of trading at Performance Trust Capital Partners. “There’s going to be buyers for a sovereign state credit at these spreads.”
Illinois state bonds were trading this week at peak levels of more than 400 basis points to AAA benchmarks. Its one-year bond was set at a 296 basis point spread to the Municipal Market Data’s top benchmark. The state's secondary market spreads weakened dramatically over March and April as investors pondered how the economic damage of the COVID-19 pandemic would impact the lowest-rated state government.
Market sources said they were told Thursday’s release of the state’s fiscal 2019 financial results prompted the delay. The state now needs to address fresh questions raised by investors that could have widened already steep yield penalties.
The Governor’s Office of Management and Budget denied that was the reason behind the decision. State officials attributed the decision late Monday to market conditions, saying the day-to-day calendar will allow flexibility to jump in at the most opportune time. It will provide at least 12-hour notice on a new sale date.
A delay may bet the state better interest rates. But that's no guarantee. “There’s a danger in waiting in that economic conditions worsen causing the state spreads to widen even further,” Battle said.
The certificates will provide cash flow to help the state stave off the growth of an unpaid bill backlog that is currently at $6.8 billion.
The market was watching closely for how the Illinois deal would fare.
“This week’s primary market includes high profile borrowings by the NY MTA and the state of Illinois,” Municipal Market Analytics said in its weekly outlook. The New York Metropolitan Transportation Authority's $700 million pricing was upsized to $1.1 billion and completed at spreads about 300 basis points north of AAA benchmark yields but was bumped a few basis points in repricing.
The MTA has been rocked by the coronavirus, which caused its ridership — and farebox dependent revenues — to plummet.
“Both represent excellent investor value at current spreads (+400bps) and carry minimal realistic near-term default risk. The MTA is too important to the NYS and US economies for the state to let fail. IL has sufficient liquidity. Both entities are likely to borrow via the MLF if their capital markets efforts see a setback; however, broad market tone may well hinge on the success these two deals,” MMA wrote referencing a Federal Reserve municipal lending program that is in the works. The state said it is not currently considering use of the MLF.
Illinois announced the May 6th sale date for the certificates last week.
They must be sold competitively under short-term borrowing statues that allow the state to make up for a shortfall in budgeted revenues. The state set May 12 for the timing of a subsequent $1 billion GO issue to fund pension buyouts and capital projects, but stressed both were subject to market conditions.
“The state of Illinois has developed its plan and is positioned to enter the market very soon if needed, but with the flexibility to assess the market as it returns from unprecedented dislocation. Like many issuers, we are going day to day and assessing conditions to determine the best time to enter the market,” Governor’s Office of Management and Budget spokeswoman Carol Knowles said in an email Tuesday. “As we stated when we announced the state’s intention to go market last week the size, timing, and structure of the anticipated transactions remain subject to market conditions.”
Spreads rocketed over the course of April as the state warned of a $2.7 billion revenue shortfall in the current fiscal year and another $4.6 billion hit in fiscal 2021 due to the economic shutdown imposed to slow the spread of the COVID-19 pandemic. The state also took one downgrade and two outlook cuts, leaving it at the BBB-minus and negative level across the board.
The state’s 10-year — which landed at a 140 basis point spread to the Municipal Market Data’s AAA benchmark in its last primary outing in the fall — opened April at a 298 bp spread with longer bonds at a 301 bp spread.
The 10-year rose steadily through April to 366 bps in the second week, 381 in the third week and closed out the month at a 391 spread.
The 10-year on Monday had widened to a 396 bp spread with longer bonds past the 400 market at a 404 bp spread.
The 10-year yield of 5.22% Tuesday represents a 275 bp spread to the BBB benchmark.
The state had planned to take bids on three tranches of $500 million, $350 million, and $350 million with the latter series callable ahead of the May 2021 maturity. The bonds carry the state’s GO ratings from Moody’s Investors Service and Fitch Ratings. Without a short-term rating it’s not eligible for purchase by money market funds, a big buyer of short term paper.
The forthcoming long-term $1 billion sales is negotiated and being led by BofA Securities. The certificates are still expected to sell ahead of the bonds, Knowles said.
Illinois took center stage last month as Senate Majority Leader Mitch McConnell pushed back against providing state governments relief in the next federal aid coronavirus aid package.
Battle believes the delay in federal aid enhances the state’s eligibility to use the Federal Reserve’s Municipal Liquidity Facility. The facility, which is still being rolled out, allows for Fed purchases of up to $500 billion of eligible short term state and local government paper that meets criteria on population and ratings. Illinois is eligible on both fronts.
Under the MLF rules, the borrower must show it was unable to secure adequate credit accommodations from other banking institutions and that it is not insolvent.
State officials however say they are currently planning only to borrow the $1.2 billion of certificates to make up for tax revenue delayed because the state delayed the April income tax deadline to match the revised federal deadline.
The notes can carry an up to 36 month maturity. “They now have a clear shot at the MLF,” Battle said. “It gives them more runway to manage the revenue problems than a one-year” maturity.
The state comprehensive annual financial results for 2019 published Thursday showed the net position of governmental activities eroded by $4 billion, pushing the deficit up to a negative $193.1 billion from $189.1 billion.
On Tuesday, the Commission on Government Forecasting and Accountability reported a $2.74 billion drop in April revenues from the previous year.
The state won’t collect about $1.3 billion in income taxes until July because of the late filing deadline.
While not counted as base revenues, $207 million of interfund borrowing took place in April. Income tax collections were down $1.7 billion for April while corporate taxes were down $377 million and sales taxes dipped by $146 million.