Illinois faces a chillier reception for its return to market
CHICAGO – Illinois faces higher borrowing costs when it returns to the market next month as investors fret over the state’s looming election, short- and long-term fiscal ills, and ability to preserve its investment-grade status.
The state will take competitive bids on $500 million of general obligation debt in two series next month. It will announce a sale date in the coming days when it publishes the official notice of sale and offering statement, according to Gov. Bruce Rauner’s administration. A $450 million series will fund general capital projects and a $50 million series will fund technology projects.
Spread penalties on the state government's paper have risen steadily throughout the year. Overall interest rates have also increased since the state’s last sale in late November.
Market participants say the rising spreads reflect uncertainty over whether gridlock returns ahead of the impending November state election and growing anxiety over the extent of the state’s fiscal ills.
“I think in general you had this intractable situation without a budget for two years so there was a relief rally in spreads” after the state actually passed a budget last summer, said Robert Miller, senior portfolio manager for Wells Capital Management. “The spreads now are reflecting not just the uncertainty of the election but questions over how is the state going to resolve their pension and budget issues.”
Rauner is running for re-election against the Democratic nominee, venture capitalist J.B. Pritzker.
The stalemate that left the state without a budget for two years was resolved in July when some GOP members broke with Rauner and joined the General Assembly’s Democratic majorities to adopt a budget package with income tax hikes and $6 billion in borrowing to pay down $16 billion in overdue bills.
Moody’s Investors Service and S&P Global Ratings, which rate the state at the lowest investment grade level of Baa3 and BBB-minus, respectively, affirmed their ratings ahead of the May deal. Moody’s assigns a negative outlook. S&P assigns a stable outlook. Fitch Ratings has Illinois at BBB with a negative outlook.
The spread between Illinois 10-year GOs and the Municipal Market Data’s benchmark rose to a high of 213 basis points Thursday, according to data from MMD municipal strategist Dan Berger.
It began March at a 197 bp spread and rose slowly throughout the month, hitting 205 bp at the start of April. It was 177 bp at the start of 2018.
The 10-year on the state’s last primary bond sale in November paid a yield of 3.91%, for a spread of 170 bp to the triple-A benchmark at the market close that day. It hovered in the 270 bp to 290 bp range last June as the new fiscal year neared and the threat of a cut of junk loomed without a budget, and hit a low of 168 bp last October post budget passage.
At the same time, yields are generally up. The 10 year was at 2.21% when the state last priced and it’s now at 2.45%. The 25-year was at 2.80% and it’s now at 2.93%.
The state’s spreads exceed what other triple-B credits pay. MMD has the BBB at 3.30%, a spread of 114 bp to the AAA, and Illinois was at 213 bp Thursday.
The state is planning a total of $1.5 billion in borrowing in fiscal 2018, which runs through June 30. The state sold $750 million toward that figure in late November. Another $1 billion is planned in fiscal 2019. “Other than the upcoming May transaction, the timing of the remaining sales has not been determined,” the administration said.
The state will have mixed fiscal news to share with investors.
After the tax hikes, revenue is on the rise. Through March, personal income taxes were up $3.28 billion and corporate income taxes were ahead of last year by $484 million, according to the non-partisan Commission on Government Forecasting and Accountability. The state's unpaid bill backlog is holding steady at $8 billion.
The state’s latest comprehensive annual financial results, however, highlighted the state’s long-term struggles with its net position of governmental activities growing to a negative $141.7 billion and its general fund deficit last year at negative $14.6 billion.
State leaders have made little headway in reaching a fiscal 2019 budget or in cutting a current-year $1 billion deficit.
Rating agencies are watching closely to see if gridlock returns and the bill backlog balloons again. Those factors, along with actions taken by state leaders that add to the state’s $129 billion pension burden or fuel growth in the deficit, could drive a cut to junk.
The rating “reflects our view of the state's recent liquidity stress because of nearly depleted budget reserves and a generally weakened financial condition, lingering structural budget imbalance even after a permanent increase to the state's individual and corporate income tax rates, and backlog of unpaid bills that remains elevated even following the recent bond refinancing of a portion of them," said S&P analyst Gabriel Petek.
The budget passage drives the stable outlook as the “likelihood of Illinois' experiencing a liquidity crisis in the coming months has fallen markedly and therefore so have the odds of its rating falling to below investment grade,” S&P added.
“The state's credit outlook is negative, based on our expectation of continued growth in the state's unfunded pension liabilities, the state's difficulties in implementing a balanced budget that will allow further reduction of its bill backlog, and elevated vulnerability to national economic downturns or other external factors,” Moody’s wrote.
The sixth-most-populous state’s economic strength and statutes that give GO debt service priority over other obligations and permit the use of billions in non-general fund accounts to pay debt service remain primary rating strengths.