CHICAGO – Illinois' yield penalties widened Thursday as the nation's lowest-rated state sold $1.3 billion of general obligation refunding bonds against a tide of negative fiscal and market headwinds.

The state's 10-year maturity landed at a yield of 3.63% with a 5% coupon, 193 basis points more than the top-rated Municipal Market benchmark and 112 basis points over a comparable triple-B benchmark credit, which is the level at which the state is currently rated.

The spread worsened from the state's last GO sale in June when the 10-year landed at 3.32%, 185 basis points over the triple-A and 111 basis points over the Triple-B benchmark. The 10-year maturity in the state's January sale saw a yield of 3.33%, a 155 basis point spread to the triple-A.

Trading on the state's 10-year had narrowed over the summer to between 160 and 175 basis points above the triple-A benchmark.

The state will return next week with a $480 million competitive GO sale.

The state's negative fiscal headlines of late combined with the deal's size, limited maturities that extended out only to 2032, and a weaker market with lots of supply drove the uptick in spreads compared to trading levels over the last month, said Brian Battle, director of trading at Performance Trust Capital Partners.

"There were a lot of bonds in a small number of maturities," which narrowed the investor base as some funds otherwise interested in the state's paper looked for higher-yielding maturities on the long end, Battle said, adding that it's hard to know how much any one factor drove the upswing in spreads. "I think it's everything together."

The market continues to benefit from inflows and a healthy appetite for yield but has weakened and there's a bounty of supply on the calendar.

As the state's budget impasse progresses, its unpaid bill backlog is nearing $9 billion. S&P Global Ratings downgraded Illinois ahead of the sale to BBB, leaving its outlook at negative.

Concerns about growing pension costs due to actuarial assumption changes at several of the state funds have driven recent headlines.

The good news for the state is it got the deal done and achieved savings, market participants said. The bad news is that the state is leaving much greater savings on the table because of its battered balance sheet and ratings.

"There is a market for the state of Illinois paper if you have a stomach for the headlines," Battle said.

The state ended up insuring the final three maturities from 2030 to 2032 with Assured Guaranty Municipal, which carries an A2 rating from Moody's Investors Service and a AA rating from S&P.

Market participants said that was a smart move because it helped attract a class of buyers interested in the 4% yield but only with the safety of insurance.

Bank of America Merrill Lynch and Jefferies ran the books. The state's last billion-dollar sale was in February 2014 when it carried A-level ratings.

Fitch Ratings affirmed its BBB-plus rating and left the credit on negative watch. Fitch will resolve the placement in January after lawmakers return for a post-election, lame-duck session to tackle a budget plan and pension reforms.

Moody's Investors Service rates the state Baa2 with a negative outlook.

The state is grappling with $113 billion of unfunded pension liabilities. While the state warned in its offering statement that potential delays in pension contributions could increase bondholder risks, it added language this week noting that delays could force funds to sell assets which could further add to risks.

The state headed into the market with some positive news as its eased liquidity risks on $600 million of paper. It has plans to remarket the bonds ahead of letter of credit expirations in a direct placement and has cemented new terms on swaps that lowered termination triggers tied to ratings.


The state achieved $106 million of present value savings on the deal with about $23 million of near term savings providing funding for the stopgap, partial budget approved over the summer. The state said it lowered its average rate on the bonds to 3.70% from the average rate of 4.96% on the bonds being refunded and it shaved two years off the final maturity on the original bonds.

"Those savings – alongside a balanced budget and structural reforms that will free up additional resources – will allow us to further prioritize funding to education and our most vulnerable," the administration of Gov. Bruce Rauner said in a statement.

The state acknowledged that its spreads widened from 10 to 15 basis points over from the June 2016 sale on various maturities but noted the "fluctuating market" and discounted the jump over recent secondary trading saying those levels are not necessarily indicative of where a deal will price.


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