CHICAGO — Illinois Gov. Pat Quinn’s recent proposals to stabilize state finances may not help shrink the interest rate penalty demanded by investors on the state’s $1.8 billion refunding set for next week, but its size and the opportunity for yield should draw solid investor demand, several market participants said.
The sale includes a mix of advance and current refunding general obligation bonds with an estimated 7% net present-value savings. Though the state faces statutory limitations on structuring, it was able to squeeze a good level of up-front savings totaling $63 million in fiscal 2012, 2013 and 2014. With a final maturity in 2026, the state is also shaving two years off the final maturity of the bonds being refunded with Tuesday’s issue.
“We wanted a nice, clean economic refunding with savings in each year, but we also wanted to capture some up-front savings,” said James Prichard, manager of capital markets for the state. “We are getting a lot of interest from investors and we should be the largest deal in the market next week, so it’s good timing.”
The book-runners, based on a rotation list of qualified firms, are Jefferies & Co., BMO Capital Markets and Duncan-Williams Inc./Rice Financial Products Co. Duncan-Williams and Rice submitted a joint bid during the state’s request for proposals process last year. Public Financial Management Inc. is advisor. Mayer Brown LLP and the Hardwick Group Inc. are bond counsel.
Ahead of the sale, all three rating agencies affirmed Illinois’ GO ratings. The credit has benefited from an income tax hike last year that is expected to generate $6.5 billion annually, but is only temporary. The state is challenged by large pension obligations, rising Medicaid costs and $9 billion in unpaid bills. Its fiscal woes have resulted in higher borrowing costs.
Moody’s Investors Service earlier this year lowered its rating for Illinois one notch to A2 with a stable outlook. It is the lowest rated state by Moody’s. Fitch Ratings rates the state’s $27 billion of GOs A with a stable outlook and Standard & Poor’s rates it A-plus with a negative outlook. The GO pledge benefits from a priority claim on state revenues.
Quinn earlier this month unveiled a plan aimed at eventually erasing the state’s $82.9 billion of unfunded pension obligations by asking employees to cut benefits in exchange for keeping health care benefits in retirement and other perks. About $5.2 billion of the proposed $34 billion fiscal 2013 budget will go to cover payments to a pension system that is only 43% funded. Quinn also recently unveiled a plan to save $2.7 billion in Medicaid spending through benefit and reimbursement cuts and a cigarette tax increase that would leverage additional federal matching funds. The Medicaid cuts would help put a significant dent in the state’s bill backlog. The proposals are before the General Assembly.
The state’s budget and liquidity crisis have forced it to pay an interest rate penalty to borrow, though that spread has narrowed since the income tax hike in early 2011. The state captured its lowest true-interest cost in memory — 3.9125% — in January on a new-money tax-exempt GO issue, benefiting from a strong market. The long bond on the state’s taxable series in that deal priced at 277 basis points over comparable Treasuries. The long bond on the state’s taxable GO sale in 2010 — before the income tax increase — carried a yield of 325 basis points over Treasuries.
The spread against triple-A tax-exempt bonds on a March GO sale ranged from 55 to 168 basis points, down by as much as 100 basis points for bonds sold before the tax hike. Market participants said the spread on state GOs has held steady at about 165 basis points in the secondary.
The state isn’t likely to reap any benefit from Quinn’s proposals Tuesday, as market concessions likely won’t come until there is legislative action, but investors searching for yield and attracted by the repayment strength of Illinois’ GO pledge are expected to be buyers. “Investors still want yield and will go after it,” said Robert Novembre, managing director at Arbor Research & Trading.
“The governor has begun to say the right things that will impact the credit positively in the long term, but investors are taking a wait-and-see approach on implementation,” said Michael Pietronico, chief executive officer at Miller Tabak Asset Management.
Illinois is under pressure to act on its finances. “If the state does not implement meaningful changes to further align revenue and spending and address its accumulated deficit for fiscal 2013, we could lower the rating this year,” S&P’s Robin Prunty wrote in the agency’s latest review. “Furthermore, we could also lower the rating by more than one notch if there is no progress on structural budget solutions and if Illinois does not address the significant pension liabilities and associated cost pressure.”q
The state will follow the sale with a $360 million sales tax-backed new-money issue later in May.