Illinois spread penalties held in check as high yields suit buyers
Illinois fared better in the market Tuesday compared to recent trading levels — especially on the short end — as investors on a hunt for yield put aside worries over COVID-19 fiscal wounds threatening the state’s investment grade ratings.
The deal's results landed close to where the state's bonds 10 years and out were trading early this month before widening by 10 basis points last week and shorter bonds saw penalties shrink by 40 basis points compared to the start of the month and 50 basis points from a week ago.
Illinois competitively sold $850 million of new-money general obligation paper in three tax-exempt tranches and one taxable series with proceeds going to finance an ongoing pension buyout program and capital projects.
The state will pay an aggregated true interest cost of 3.948%, low when compared to historic levels but punishing given the market’s attractive rates with the Municipal Market Data’s 10-year AAA benchmark set at 0.96% at the market close Tuesday and the BBB benchmark at 2.22%. The state is rated one level above a speculative grade with Fitch Ratings, Moody’s Investors Service, and S&P Global Ratings all assigning a negative outlook.
“The state of Illinois is pleased to have received a strong response from the municipal bond market in one of the busiest weeks in nearly 20 years,” Paul Chatalas, the state’s capital markets director, said in a statement. “We appreciate the ongoing support of our investors … and we appreciate the bids from the banks who represented them.”
BofA Securities won two tranches for $300 million and $325 million.
The five-year in the deal was set at 2.58% yield with a 5% coupon, a 230 basis point spread to Refinitiv MMD’s AAA benchmark. Headed into the deal, the state’s five-year had been set by MMD based on secondary market trading levels over the last week at a 281 bp spread to the AAA up from 271 bps at the start of the month.
A 10-year bond paid a 3.64% yield with a 5% coupon, a 270 basis point spread to the AAA. The state’s 10-year had been set by MMD over the last week at a 281 basis point spread up from 271 basis points at the start of October. The 10-year yield of 3.64% represented a 144 basis point spread to the BBB where Illinois is rated.
A 20-year landed at 4.30% with a 4% coupon, a 260 basis point spread based on a 4% coupon adjustment, according to MMD’s market close column. The 20-year was set over the last week at a 269 basis point spread and started the month at a 259 basis point spread.
JPMorgan won the $100 million tax-exempt tranche and $125 million taxable tranche. The spreads to Treasuries on the $125 million taxable tranche ranged from 175 basis points to 290 basis points on the bonds that went out to 2025.
The 2023 maturity in the $100 million tax-exempt tranche paid a yield of 1.94%, a 175 basis point spread to the AAA. Headed into the deal, the state’s 2023 bonds had been set based on trading levels at a 263 basis point spread up from 253 basis points at the start of the month.
The state borrowed from the Federal Reserve’s Municipal Liquidity Facility in May at an interest rate of 3.82% for its one-year certificates. The state’s budget authorizes as much as $5 billion of additional borrowing through the MLF with the current rate set at 3.30% based on the state ratings.
The state captured better rates in the market Tuesday but the MLF provides a direct path to borrowing that averts potential market turmoil and headline risk — which drove up state spread penalties to peak levels in a May sale.
In response to Tuesday’s scale on the deal, MMD narrowed the state’s yield curve down 50 basis points on the one-year to 175 basis points, down 50 basis points on the five-year to 231 basis points, down 12 basis points to 269 basis points on the 10-year, down 12 basis points to 257 basis points on the 20-year, and down 12 basis points on the 25-year to 256 basis points. That’s a few basis points better 10 years and out and 30 to 40 basis points narrower on the short end.
“As a result we ended up tightening IL GO spreads 10-30 basis points on average with potentially more work to do after we see bonds start trading in the secondary,” said Greg Saulnier, managing analyst, U.S. Municipal Bonds at Refinitiv.
Saulnier and traders said the deal was expected to come at aggressive levels as buyers hunt for yield amid the crowd of issuance. “On top of that, a few people have remarked to us that should a ‘blue wave’ of Democratic wins play out in the upcoming elections, they expect state and local governments to get plenty of aid that will only strengthen munis. Perhaps there was a bit of that thinking at play here too,” Saulnier said.
The state paid peak spread penalties in May stung by a market hangover from March and April as investors looked to high-quality credits amid lingering worries over liquidity and jitters over headline risk were on display.
The all-in, true interest cost of the May deal settled at 5.83% with the 10-year bond in the deal landing at 5.65%, a 452 basis point spread to the MMD AAA and a 331 basis point spread to the BBB benchmark. The one-year maturity in that deal landed at a 4.875% yield for a 433 basis point spread to the AAA scale.
Market sources said the deal came as expected, given the ratings and the budgetary pressures the state is facing, the uncertainties of the elections and the ongoing COVID-19 crisis.
"Every issuer under the sun is trying to get in before the elections, Illinois included," a Chicago trader said. "When you look at what the state has weathered so far in 2020, it's actually quite remarkable, given what's transpired. Yield investors did demand more from the state this go round, but perhaps not as much as it should have been penalized. In a different, post-crisis, higher-rate environment, we may have been seeing much more concession from the issuer."
When the state sold bonds in November, 2019, the 10-year landed at a 140 basis point spread, although the coupons differed.
The stark widening between November and May highlighted the pandemic’s toll on investor sentiment with the state’s structural budget woes and $137 billion pension tab and threatening its investment grade ratings in the forefront.
Gov. J.B. Pritzker’s administration said in Tuesday’s sale, the state received nine bids on the $125 million taxable tranche won by JPMorgan for a TIC of 2.8259%.
The state received nine bids on the $325 million tranche won by BofA with a TIC of 3.707587%.
The state received nine bids on the $300 million tranche also won by BofA with a TIC of 4.315669%.
The state received 12 bids on the $100 million tranche won by JPMorgan with a TIC of 2.153456%.
The state typically receives aggressive bids from investment banks on its competitive deals as the state considers that participation in its selection of syndicates on negotiated sales.
Illinois now awaits the November election results that will determine the fate of its progressive income tax question championed by Pritzker. If voters scrap the flat structure required under the state constitution, the state would raise rates on the top 3% of earners, generating about $1.3 billion for the fiscal 2021 budget and $3.1 billion for a full year in the future.
If it fails, the state may tap general obligation borrowing authority to make up the 2021 difference. The state also has $5 billion in legislature-authorized borrowing through the MLF that would be tapped if additional federal relief isn’t approved this fall. With relief stalled, the buy side expects the state to cut spending during its fall veto session next month to preserve its investment grade ratings.