Don’t count individual investors out of Illinois’ general obligation offering. The potential for meaty spreads will satisfy some yield-starved retail accounts when the first serving of the $6 billion offering is priced competitively on Tuesday.
In addition, experts said the multi-series deal has the potential to attract a wide audience of buyers and reprice the general market, based just on its size and timing amid the current market's low rates and tight spreads.
The state will test the waters with its first tranche of $1.5 billion of bonds pricing in three series — each for $500 million — as part of a total of $6.75 billion of planned fixed-rate, tax-exempt GO borrowing, which included $6 billion to pay down a backlog of bills that currently stands at $15.4 billion.
Tuesday’s deal matures in 2018, 2019 and 2029. The generic, triple-A GO benchmark in 2029 yielded a 2.12% as of Oct. 13, according to Municipal Market Data.
Some in the retail crowd will be willing to look beyond the state’s current political wrangling and budget imbalance, pension liability growth and funding pressures, and warnings of possible ratings downgrades to junk in order to capture significantly higher yields than the general market, analysts said.
“I suspect institutional interest will drive the deals, but retail demand should also be robust,” Alan Schankel, managing director and municipal strategist at Janney Capital Markets, said on Friday. “With yields near high yield territory and little yieldy supply available, a state GO with statutory debt service priority will be attractive to more risk-tolerant investors.”
Though the state’s GO spreads have fluctuated recently and may come tighter than its prior GO sales last year — market experts say the lack of attractively priced, near-speculative paper and low overall supply should attract a hungry investor crowd, including retail.
Illinois paid a 200-basis point spread on the 10-year maturity in its last GO sale for $480 million in November 2016. It saw spreads of 193 basis points on a $1.3 billion GO refunding in an October 2016 sale, and 185 basis point spread on a $550 million June 2016 sale.
The 10-year spread hit an all-time peak of 335 on June 8 after an adverse court ruling on Medicaid payments. The spreads rebounded and hovered between 273 and 292 basis points until July after the budget passed when they dropped to about 200.
Moody’s Investors Service rates the state at the lowest investment grade level of Baa3 with a negative outlook, and warns of a downgrade to junk. S&P Global Ratings also has the state at the lowest investment grade of BBB-minus with a stable outlook, while Fitch Ratings rates the state one notch higher at BBB, with a negative outlook.
Others, meanwhile, said a mammoth deal such as Illinois’ has the potential to impact prices in the general market – just based on size alone.
“We hope that the large issuance helps to reprice the general market so more attractive levels bring more investors to the marketplace,” said Jim Colby, senior municipal strategist at Van Eck Global. “It is not a tsunami, but wave after wave of BBB-minus bonds.”
With such a large influx of triple-B minus ratings on the precipice of high yield, the question is “how many retail or institutional buyers, with any knowledge of the needs and terrible political climate in the state, can readily absorb such a large amount of bonds?” Colby said.
Not all institutional investors may jump on the first tranche of the deal either, he said. Large institutional accounts — wanting to take advantage of the most attractive price on the bonds — may hold out for “better yields a week or two down the road,” according to Colby.
Investors will have two more opportunities to buy Illinois GOs when the state returns the week of Oct. 23 with $4.5 billion in a negotiated sale — its largest single transaction since its $10 billion pension GO borrowing in 2003.
Another deal for $750 million is planned in December to fund fiscal 2018 capital projects.
“At some price, the bonds will get sold, and I am not sure what that level will be,” Colby said. “But, that selling/placement process is likely to cause spreads for other bonds to widen out as a normal reaction to abnormally large supply entering the market.”
Schankel said since Illinois is an outlier — particularly among states — he sees little chance of the deal repricing the general market. Still, he expects hearty demand based on an “attractive differential” in spreads.
He pointed to a nearly 170 basis point spread on Friday between the Bloomberg 12-year, triple-A yield at 2.20% and the Bloomberg 12-year Illinois index at 3.89%.