All eyes turned to Illinois municipal bonds Friday after the state Senate failed to pass a comprehensive pension reform package.
Illinois general obligation bonds are rated A2 by Moody’s Investors Service, A-minus by Standard & Poor’s and A by Fitch Ratings. All agencies have the credit on either negative watch or outlook and have stated the credit faces a downgrade if pension reform is not addressed.
On a quiet Friday afternoon, few Illinois bonds traded in the secondary, but market participants said there could be fallout if the failure of pension legislation does lead to a rating cut.
As of Thursday afternoon, the 10-year Illinois GO scale traded 140 basis points above MMD scale. It had tightened from 158 basis points from April 1 but was trading even with the 140 basis-point spread on March 1.
“For a GO credit, the spread is wide,” said Adam Buchanan, vice president of municipal credit at Ziegler Capital Markets. “As a single-A rated credit, 140 basis points is cheap and a nice buy, but if there is a downgrade, a triple-B rated evolving credit at 140 basis points off, is not cheap.”
A rating downgrade would penalize the state for its inaction.. “Illinois frequently comes to market and they will have to pay a higher cost of capital in a rising interest rate environment,” Buchanan said.
Others said a downgrade was already priced in. “I’m looking at an Illinois 5% coupon in 2025 and its evaluated at 3.66%,” a New York trader said. “That’s in line with MMD’s triple-B scale at 3.64% for a bond maturing in 2025.”
Going back to November, this trader said, Illinois was priced between a single-A and triple-B credit. “But now a downgrade is priced in. Illinois is at triple-B levels or very close to it.”
In the general muni market Friday, activity started to slow after a backup in yields earlier in the week. Traders started to look toward next week and June 1 money flooding accounts.
“I like taxable munis right now with the nice back up in Treasury yields,” a trader in Ohio said. “I’m still not a fan of tax-exempts but as long as sellers aren’t too proud of their offerings I could see the secondary market doing okay next week thanks to June 1 reinvestment money and seemingly manageable supply expected, despite the underwhelming muni-to-Treasury ratios.”
With the backup in yields this week, secondary trading activity fell. In retail trades of under 100 bonds, there were 47,997 buy trades, down the from previous week’s 58,287, according to BondDesk Group. There were 28,454 sell trades, down from 35,914 the previous week.
Par value of buy trades fell to $1.293 billion, from the previous week’s $1.612 billion. Sell trades came in at $783 million, down from $994 million.
Yields on the Municipal Market Data scale ended as much as two basis points higher. The 10-year and 30-year yields rose two basis points each to 2.09% and 3.24%, respectively. The two-year finished flat at 0.29% for the sixth session.
Yields on the Municipal Market Advisors 5% scale also ended as much as two basis points higher. The 10-year and 30-year yields rose two basis points each to 2.14% and 3.34%, respectively. The two-year finished steady at 0.36% for the third session.
Treasuries weakened Friday. The benchmark 10-year yield increased four basis points to 2.16% and the 30-year yield climbed two basis points to 3.30%. The two-year yield increased one basis point to 0.31%.