CHICAGO — Illinois has picked Public Financial Management Inc. to serve as financial adviser and Citi and Barclays Capital to lead a team of 11 broker-dealers on its sale of up to $1.75 billion of tobacco bonds planned for later this year to provide budgetary relief, sources said.

Members of the team will meet with the state on Wednesday to begin working on structural issues, according to public finance sources. The state is hoping to use a tax-exempt structure and would sell between $1.4 billion and $1.75 billion of debt with a maturity limited to 19 years. The bonds would be backed solely by tobacco settlement payments. The Railsplitter Tobacco Settlement Authority, created by the state for this purpose, will issue the bonds.

Citi is book-runner and Barclays is co-book-runner.  Jefferies & Co. Inc., JPMorgan, and Morgan Stanley are co-senior managers.

Bank of America Merrill Lynch, Goldman Sachs & Co., Grigsby & Associates Inc., Loop Capital Markets LLC, Morgan Keegan & Co., and Siebert Brandford Shank & Co. are co-managers. Illinois notified firms last week of their selection to participate in the transaction.

State debt manager John Sinsheimer on Friday declined to comment on finance team members, saying he was waiting for an award notice to be published on the state’s procurement website. The firms participated in a request for proposals process conducted in August.

The firms were chosen based on a scoring system. Senior manager applicants were asked in the RFP to list team members and experience in tobacco securitizations and on Illinois deals, to provide details of a marketing plan, and to provide their bank’s capital position and willingness to use its own balance sheet to support the transaction.

Citi has served as a senior manager for 31 tobacco deals since 2000, according to Thomson Reuters. Barclays did not become a major player in the sector until it acquired Lehman Brothers’ broker-dealer in 2008. Tobacco banker Kym Arnone left Bear Stearns & Co. earlier in 2008 to join Lehman.

During her tenure, Bear was a top tobacco underwriter, leading Ohio’s $5.5 billion sale and California’s $4.4 billion issue, both in 2007. Barclays last year was the lead manager on Wisconsin’s appropriation-backed bond sale that refunded $1.4 billion of tobacco bonds.

Barclays served as the lead manager on Illinois’ sale of $1 billion of Build America Bonds in January and Citi was the lead manager on its $900 million BAB issue in July, and won the competitive bidding on $300 million of BABs in June.

Officials want to sell the tobacco bonds before the end of the year. Illinois’ budget struggles are driving the timing, which comes amid tough times for the tobacco sector.

That’s because national settlement payments are lower due to a drop in consumption by cigarette smokers, promoting negative rating actions and raising concerns over looming defaults, especially for those bonds with longer maturities.

Legislation approved earlier this year allows the state in fiscal 2010 and 2011 to transfer to the authority 100% of its right to tobacco revenue from the 1998 Master Settlement Agreement between most states and the major tobacco companies. In exchange, the authority will provide the bond proceeds to Illinois to bolster its general fund.

It was among the one-time measures lawmakers approved to deal with a $12 billion deficit. The deal would mark the first tobacco sale by Illinois.

The transaction would also mark the last in a series of new-money and refunding issues sold since September that have totaled $9.6 billion.

Gov. Pat Quinn would like to sell $3.7 billion of GO pension bonds but lawmakers have not yet authorized the financing. The tobacco deal is not expected to sell before the Nov. 2 election.

Quinn, a Democrat, is locked in a tight battle with his Republican challenger state Sen. Bill Brady of Bloomington. Brady has attacked Quinn’s use of borrowing to help deal with the budget crisis and his push to raise the state’s income tax.

Under the 1998 MSA, Illinois was to receive $9.1 billion through 2025, but actual payments depend on a complex formula. Dick Larkin,  director of credit analysis at Herbert J. Sims & Co., recently warned in a report that the shrinking pool of smokers puts billions of dollars of bonds backed solely by MSA payments in jeopardy of default as soon as 2030.

To maximize investor interest, Illinois will need to keep maturities short to avoid pricing penalties associated with extension risk and should leave a good amount of cash-flow coverage.

“The way to increase the value of the bonds is to keep the maturities shorter and set a higher break-even point at which the bonds can withstand consumption declines of at least 5%,” Larkin said.

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