Illinois Returning to Market with Sales Tax Bonds
CHICAGO – Illinois will return to the market with $573 million of new money and refunding bonds under a higher-rated sales tax-backed credit.
Fitch Ratings said the state will take competitive bids Aug. 24 on a $150 million junior obligation tax-exempt series and a $60 million junior taxable series. The next day it will take bids on $164.3 million of a junior tax-exempt refunding series and a $198.6 junior tax-exempt refunding series.
The bonds will finance various capital projects, refund certain of the state's outstanding Build Illinois Bonds for savings, and pay costs of issuance, a state spokeswoman said.
The sale is the first under the state's Build Illinois credit since 2014.
Ahead of the issue, Fitch affirmed its AA-plus rating and stable outlook for bonds issued under the Build Illinois program. The program has $1.86 billion of senior lien program debt and another $654.4 million of junior lien paper outstanding.
The rating marks a sharp contrast to the state's general obligation rating, which has been battered by a $5 billion to $6 billion budget deficit, a mounting bill backlog, and $112 billion of unfunded pension liabilities.
Fitch rates Illinois GOs BBB-plus and in June put the rating on Rating Watch Negative as a long-term budget solution continues to elude the state amid prolonged partisan gridlock.
Build Illinois bonds enjoy a first claim on the state's 6.25% sales tax, which generated $8.6 billion last year to provide healthy debt service coverage levels of 10 times on the junior lien. Stringent limits on new issuance keep debt service to no more than 5% of the state's prior year sales tax receipts on the senior lien and 9.8% on the junior.
"Build Illinois bonds have a statutory first lien on the state's share of the sales tax, strong non-impairment language, and no requirement for annual appropriation," Fitch wrote in its new review. "In Fitch's opinion, these provisions insulate the bonds from state operations and support a rating level that is higher than that of the state's Issuer default rating."
S&P Global Ratings also recognizes the distinction with the GOs. It affirmed the Build Illinois bonds at AAA Wednesday, along with the negative outlook it assigned in June.
"Increased liquidity pressures on Illinois could test the ability of these revenues to remain isolated from the
state and its fiscal pressures," analyst John Sugden said.
Moody's Investors Service does not differentiate between the sales tax-backed bonds and Illinois GOs, assigning them its Baa2 rating with a negative outlook.
While contract clause protections under federal and state constitutions restrict the ability of a state government to impair the bondholder pledge of the dedicated tax, the contract clause does not impose an absolute constraint when there is a fiscal emergency.
"Therefore, the amount of credit Fitch will give to such a structure is tempered by the risk that a state, faced with extreme financial stress, could exercise its sovereign powers to the detriment of bondholders," Fitch added.
Sales tax collections declined by 12% during the most recent recession but have picked up speed, growing by 4.1% in 2014 and 4.5% in 2015. Current growth has slowed, in part due to lower gasoline prices, Fitch said.
In the state's last Build Illinois deal in March 2014, it received seven bids on the $402 million taxable issue with JPMorgan winning the bonds with a true interest bid of 4.2706%. While the sales tax-backed bonds were subject to an interest rate penalty for the Illinois name, the higher ratings shielded them from the steeper penalties spreads impose on the state's stressed GO paper.
The spreads ranged from 25 basis points to 105 basis points to comparable Treasuries, below the spreads of well over 100 basis points on its GOs to comparably rated GOs throughout the scale.
On its most recent GO sale in June, the state paid a true interest cost of 3.7425% and saw spreads of about 185 basis points to the Municipal Market Data's top-rated benchmark on its 10-year maturity and 172 basis points on its 25-year.