Illinois Gaining Most in 2 Years Belies Pension Gap: Muni Credit
Illinois debt is close to the strongest in two years even after state lawmakers failed for the second time since August to fix the nation’s worst-funded pension system.
The $97 billion of unfunded retirement obligations that Democratic Governor Pat Quinn has likened to a python strangling Illinois are rising by $17 million a day. Moody’s Investors Service rates Illinois A2, five steps below the top rank and the lowest among U.S. states. Last month, it threatened another downgrade without pension changes.
Yet investors such as Eric Friedland at Schroder Investment Management North America said they expect the state will repay its general-obligation securities even though it faces a backlog of $8 billion in bills from vendors. The extra yield buyers demand on debt from Illinois and its localities shrank to as little as 1.32 percentage points over AAA munis last month, the least since February 2011.
“I anticipate credit quality will diminish, but at the end of the day, Illinois G.O. bonds aren’t going to ever default,” said Friedland, head of muni-credit research in New York at Schroder, which oversees about $2 billion of the bonds. Rating companies will probably cut the state’s credit another level, he said.
Illinois lawmakers ended their 2012 session Jan. 8 without restructuring the retirement systems, which have 43.4 percent of assets needed to cover obligations, the nation’s weakest ratio, data compiled by Bloomberg show. The inaction is a “slow strangulation” of the state’s economy, Richard Ravitch, a former New York lieutenant governor and co-head of a task force that studied Illinois finances, said in an interview this week.
For investors in the $3.7 trillion muni market, the state’s reduced credit quality provides a chance to lock in extra yield with interest rates near the lowest in a generation. Illinois by law must appropriate funds for debt service, according to a 2011 Fidelity Investments report that ranked it among the seven states with the strongest legal provisions.
Tax-exempt Illinois general-obligation bonds due in January 2017 traded yesterday at an average yield of 1.8 percent, compared with 0.7 percent for benchmark munis, data compiled by Bloomberg show.
Illinois securities have returned 2.7 percent since Aug. 17, trailing only Ohio and California among 26 states tracked by Standard & Poor’s indexes. That was the day lawmakers failed to use a special one-day session to overhaul the pensions, prompting then-state Representative Daniel Biss to say the legislators “look like idiots.”
In an interview this week, Biss, who was elected in November to the state Senate, said Illinois “may learn from Wall Street very shortly about the importance” of fixing the pension systems.
About two weeks after the August session, Standard & Poor’s cut Illinois’s credit one level to A, sixth-highest, citing retiree costs. The New York-based company maintained its negative outlook, signaling another downgrade may occur. Only California, ranked A-, has a weaker rating among U.S. states.
For the legislators, “it’s easy to disagree -- it’s hard to be constructive and find mutual buy-in,” said James Spiotto, a bankruptcy attorney at Chapman & Cutler LLP in Chicago. “The reason the legislature is there is to make these hard decisions.”
Quinn told reporters at Bloomberg’s Chicago bureau last month that there’s “a clear and present danger” of another downgrade if lawmakers don’t restructure the pension system. That same week, Moody’s revised its outlook on the state to negative.
The outlook was based on the prospect for pension changes in the “coming months, not just in the lame-duck session,” Ted Hampton, Moody’s lead analyst on Illinois, said yesterday.
“This is not the time” to buy the state’s general- obligations, Friedland said. “But if I saw a downgrade and spreads widened as a result of that, at that point you may be able to get a good return on the bonds.”
If the past year is any guide, further rating cuts may not quash the Illinois rally.
The yield spread over benchmark Treasuries on taxable Illinois pension debt maturing in 2033 narrowed to 2.56 percentage points Jan. 8, the smallest since April, data compiled by Bloomberg show.
The pension liabilities have “confounded Illinois legislatures and governors for 70 years,” Quinn said. Lawmakers began a new session yesterday with pledges to try again.
In trading yesterday, benchmark munis rallied across most maturities, with 10-year yields falling 0.06 percentage point to 1.75 percent, the lowest since Dec. 31, Bloomberg Valuation data show.
Following is a pending sale:
New York’s METROPOLITAN TRANSPORTATION AUTHORITY plans to sell $500 million of revenue bonds as soon as next week, according to offering documents. The proceeds will be used to finance transit and commuter projects. (Added Jan. 10)
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