Illinois GO spreads hit 12-month low after Moody's outlook boost

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CHICAGO – Illinois general obligation bond spreads tightened after Moody’s Investors Service removed its negative outlook on the state.

"Illinois GO yields have been gapping lower after Moody's upgraded its outlook to stable,” Thomson Reuters Municipal Market Data’s analyst team wrote in a daily market column. “On Friday, MMD elected to tighten IL GO spread throughout the yield curve. IL GO spreads are now at their 12-month lows."

Moody's revised its Illinois outlook on Thursday.

Spreads narrowed in secondary market trading to a range of 150 basis points to 153 basis points over the MMD’s top-rated benchmark spread compared to recent trading levels at 165 bp, MMD said. In the 10-year range, the current level marks a low since May 2015.

MMD saw several sizable blocks of Illinois paper trade hands, saying one 2028 maturity with a 5% coupon illustrates the price impact of the outlook shift. The maturity traded Friday at a 153.8 bp spread and price of $108.094, compared to 167.1 bp spread/$107.030 price on Thursday, and a 168.9 bp spread/$106.735 price on Wednesday.

The state’s primary and secondary spreads have fluctuated widely over the last three years, deteriorating as the budget impasse between Gov. Bruce Rauner – a Republican who took office in 2015 – and the Democratic-led General Assembly dragged out and the state’s ratings suffered.

At times, spreads narrowed as officials reached agreement on some temporary spending matters and fiscal pressures eased but they again worsened as the state neared a cut to junk in the first half of 2017.

The state’s 10-year peaked at more than 335 bp in June 2017 due to an adverse court ruling that signaled Illinois would soon be required to speed up the payment of hundreds of millions in overdue Medicaid payments. It hovered around 270 bp over the next few weeks and then tumbled to 200 bp after the fiscal 2018 budget and income tax hike were approved in July 2017 when lawmakers overrode Rauner’s vetoes.

The state’s 10-year spread was at 168 bp last August and finished 2017 at 177 bp.

Spreads had been on the rise this year as investors worried over whether budget gridlock would return, rising to a secondary peak of 205 bp at the end of March. In the primary, the state’s 10-year in an April sale landed at a 210 bp spread compared to a 170 bp spread last November.

With state elections looming in November, lawmakers tamped down their rhetoric and reached agreement on a spending plan ahead of a May 31 deadline and spreads dropped to 165 bp.

They had hovered around 165 bp to 170 bp during June and early July, dropping to 153 bp last Friday.

Moody's Baa3 rating remains at the lowest investment grade level.

While the rating action was limited to an outlook change, it was a significant shift from the agency that had Illinois closest to a downgrade. S&P Global Ratings was at an equivalent BBB-minus but already assigned a stable outlook, and Fitch Ratings has Illinois at BBB with a negative outlook.

Moody’s has also appeared, at times, more unpredictable.

As state lawmakers were poised to break the budget impasse during the 2017 Fourth of July holiday week and Fitch Ratings and S&P Global Ratings made positive comments on the looming action, Moody’s put the state under review for a downgrade.

Just ahead of the May 2018 vote on a new budget, Moody’s issued a report warning that Illinois was facing an “inflection point as unfunded pension burden poised to accelerate” and that a “failure to adopt mitigating strategies soon will greatly increase the state’s risk that these rising costs will become unaffordable without severe public services cuts.”

The report accompanying Thursday's outlook shift offered some calming words for investors.

“The state's stable outlook is in line with expectations that, despite continued under-funding of pension liabilities, any credit deterioration in the next two years will not affect the state's finances, economy, or overall liabilities to an extent sufficient to warrant a lower rating,” Moody’s wrote.

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