Illinois will bond for pension buyouts, may cancel swaps

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CHICAGO – Illinois’ new state budget paves the way for the state to pay off swaps tied to $600 million of floating-rate debt and authorizes $1.8 billion in new general obligation borrowing to finance pension buyouts and capital projects.

The new GO authority -- $1 billion for the buyouts and $800 million for capital -- is lean and falls far short of a fiscal 2019 capital budget that totals $16.8 billion when new authorizations of $7.8 billion are counted along with $9 billion in reauthorized projects. Most of them won't be funded this year.

The final plan adopted last month closely mirrors Gov. Bruce Rauner’s original proposal from earlier in the year and relies on about $3.6 billion in borrowing and $4.2 billion in cash to cover the new appropriations. What projects will actually get funded remains clouded.

“Since the fiscal year 2019 budget does not raise any additional revenues for capital projects, it is unlikely that a majority of the appropriations will be spent during the fiscal year,” the Chicago Civic Federation research organization wrote in an overview of the capital plan. “Authorized projects that are not completed or started may be rolled forward with re-appropriations in future years.”

Notable line items include $53 million to begin the design and construction of a new $200 million state-run veterans’ home in Quincy that’s seen deadly outbreaks of Legionnaire’s disease over the last several years, and $190 million for transportation-related improvements tied to the Obama Presidential Center in Chicago.

The capital budget allocated $2.2 billion to the Illinois Department of Transportation for road projects in pay-as-you-go funds as part of an $11 billion fiscal 2019 to 2024 long-term highway improvement plan.

The state’s last major capital plan – the $32 billion Illinois Jobs Now approved in fiscal 2010 – is winding down and the taxes enacted to help repay that borrowing have fallen short of expectations, leaving the state to dip into general funds.

“It has been over 28 years since Illinois has raised its motor fuel tax and revenues have not kept up with the cost of construction,” the Civic Federation wrote. “The Illinois Jobs Now! plan relied on a package of revenues, such as video poker taxes, that failed to materialize as projected. Moreover, that plan and capital budgets since then have lacked a comprehensive assessment and prioritization of the state’s capital needs.”

Lawmakers from both sides of the aisle are clamoring for a new capital plan, but it’s been pushed to the back burner amid the bickering that left the state without a budget for two years. That impasse helped drag the state’s ratings to near junk, driving up borrowing costs. The state’s spread to benchmark indices is between 155 basis points and 185 bp depending on the maturity. More recently, lawmakers were able to pass a fiscal 2019 budget on time and have shifted to the November elections.

The Republican governor is facing wealthy businessman J.B. Pritzker, all House seats are up, and one-third of the Senate's. Democrats hold a simple majority in the House and a three-fifths supermajority in the Senate.

“I’m going to do a big capital bill here in the next six months to invest tens of billions” on top of previously announced road and bridge spending authorized in fiscal 2019, Rauner said during a public appearance earlier this month. A specific revenue plan to raise the needed cash or repay borrowing has not been outlined.

Pritzker touts the need for new infrastructure spending but has not offered funding details. “As governor, I will prioritize a comprehensive 21st Century Capital Bill to build the infrastructure we need to restore Illinois’ place as an economic leader,” his campaign site says. “My plan will leverage as much federal money as possible to bring significant investment to our surface, rail, water, broadband and community infrastructure.”

The authority to issue debt to pay make termination payments on its swaps would allow the state to shed the derivatives and, in turn, floating-rate debt that gave it headaches as it neared termination events due to its ratings slide, according to the Civic Federation’s review.

The swaps carried a negative valuation of $83 million as of April, according to state disclosure documents, and the state is facing a November 17 mandatory tender on the floaters. “We will have a solution well in advance of the expiration of the direct placement facilities,” Rauner spokeswoman Elizabeth Tomev said Tuesday. The state could refinance the floaters and issue debt to cancel the swap or seek out new agreements.

Illinois first negotiated new terms with on its five swaps with four counterparties in 2016 which included the novation of two, to lower the ratings thresholds that would trigger termination events. The counterparties lowered the rating thresholds again last June so that a two-notch downgrade into junk territory would begin triggering termination events.

The state carries two ratings at the lowest investment grade level, with Fitch Ratings one notch higher at BBB.

Barclays is counterparty to two swaps each for $54 million, Bank of America is on one for $54 million, JPMorgan Chase is on one for $54 million, and Deutsche Bank is on $384 million.

In 2016, the state remarketed the floating-rate paper in a direct placement with four banks. The bonds bear either a LIBOR or SIFMA-based interest rate that rises if the state is downgraded.

DNT Asset Trust accounts for $226 million, PNC Bank NA accounts for $224 million, State Street Public Lending Corp. accounts for $75 million and RBC Municipal Products LLC accounts for $75 million.

The state’s spread previously rose to 3.45% from 2.95% based on downgrades last June. If one of its ratings falls to junk the fee increases to 5.45%. If at least two drop the state to junk, the spread rises to 645 basis points. If any of its ratings fall to Ba2/BB, the spread jumps to 745 bp.

State debt service peaks this year at $4.4 billion and then declines by $1 billion next year as bonds issued in 2011 to cover pension payments are retired. The state owes a total of $32.2 billion in principal and $14.2 billion in interest on $14 billion of GOs for capital, $2.3 billion of Build Illinois sales-tax bonds, the $6 billion of GO bill backlog pay down debt issued last fall, and $9.9 pension-related GO debt. The backlog borrowing carries $1.8 billion of interest and is retired in fiscal 2030.

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Credit derivatives State budgets Public pensions Infrastructure Bruce Rauner State of Illinois Illinois