CHICAGO – Illinois plans to return to the market next month with a $1.3 billion general obligation refunding, followed by a $480 million new money issue.
The refunding will sell through negotiation the week of Oct. 10 with Bank of America Merrill Lynch and Jefferies jointly running the books. Both were drawn from the 15 firms named by the state to a new senior manager pool. BAML was the winning bidder on several of the state's most recent competitive GO issues.
A stopgap budget package approved over the summer authorized the sale of up to $2 billion of refunding debt that frees the refunding through fiscal 2017 of many decade-old structuring rules that state officials have complained stymie refundings.
The new-money GOs will fund capital projects and be sold competitively the following week. The state uses both competitive and negotiated sales on its general obligation and sales-tax backed borrowing with statutes requiring that at least 25% of annual GOs be sold competitively.
The state has paid steep penalties to borrow amid a political stalemate over the fiscal 2016 and 2017 budgets.
Gov. Bruce Rauner, a Republican, and the Democratic controlled General Assembly approved a partial, stopgap budget in June after failing to resolve longstanding differences that have blocked them from putting together a full budget. They are expected to return after the November election to work on a long-term budget solution and pension reforms.
The state must close a $5 billion deficit and faces a growing bill backlog. The current backlog stands at $8.3 billion, according to the state comptroller's website, and is projected to top a record $10 billion by the close of the fiscal year June 30.
Illinois is the lowest-rated state and pays the greatest credit spread among states. On the state's most recent GO sale in June, it saw spreads of about 185 basis points to the MMD top-rated benchmark on its 10-year maturity. In contrast, its August sale of high-grade sales tax-backed paper saw 10-year yields land at 48 basis points over the Municipal Market Data's scale's triple-A yield.
At the same time, the state has seen record low true interest costs thanks to low prevailing rates in the municipal bond market.
Moody's Investors Service and S&P Global Ratings rate Illinois Baa2 and BBB-plus after recent downgrades and assign a negative outlook. Fitch Ratings assigns a BBB-plus rating and has the credit on negative watch.
"If no progress is made on a full-year budget by next year, it would not be surprising to see additional rating downgrades by mid-2017," Nuveen wrote in a recent report comparing Chicago and Illinois. "Investors should be prepared for the political process in Illinois to remain volatile over the next six months and expect market moving headlines to continue."
The state did not provide an update on whether the deals address issues tied to expiring letters of credit on $600 million of floating-rate debt. If the state fails to renew the LOCs that expire in late November, the bonds have a three-year term out at a higher rate, according to S&P.
Moody's recent cut puts Illinois one downgrade away from triggering termination events on five interest-rate swap agreements tied to the $600 million while the S&P cut puts it two notches away. The swaps are negatively valued at $155 million.
Moody's on Wednesday affirmed the state's rating ahead of the planned sales.
"The rating factors in severely underfunded pension plans, failure to address a structural deficit because of a political impasse, and narrow operating fund liquidity that is driving up a backlog of unpaid bills," analysts wrote.
The refunding of outstanding GOs from issues between 2002 and 2006 is expected to generate net present value savings of 8.7%, or $121 million, and provide $20 million of relief in current year debt service, and the new money would sold at a premium to raise $500 million, according to Moody's.
The state budget office Wednesday also defended its assertion that the deficit is in the $5 billion range. The nonpartisan Commission on Government Forecasting and Accountability warned in a recent report the gap is as high as $7.8 billion. The state said COGFA's numbers are based on some outdated information involving Medicaid reimbursements, and didn't count the use of rainy day funds in the stopgap budget, or refunding savings. The state must disclose its best assessment of the numbers in its upcoming offering statements.
The co-senior managers on the negotiated sale are Loop Capital Markets, PNC Capital Markets LLC and Ramirez & Co. Inc. Another five firms will serve as co-managers. Bond and disclosure counsel on both sales is Chapman and Cutler LLP and co-bond counsel is Hardwick Law Firm LLC. Public Resources Advisory Group is advising the state on both deals, according to the governor's office.