July 14 (Bloomberg) -- Illinois, whose comptroller said the state is in the worst financial position in its history, may face a risk premium that is about 11 percent above what it paid last month when it sells $900 million of Build America Bonds today.
The state, selling the federally subsidized taxable debt to pay for transportation and various capital projects, borrowed $8.7 billion in the fiscal year ended June 30, the most since it sold $10 billion to fund its pension plan contribution in fiscal 2003, according to data compiled by Bloomberg.
Illinois is authorized to borrow $3.9 billion in the fiscal year that began July 1, including the Build Americas and $1.3 billion of short-term debt to cover revenue shortfalls forecast later this month. The state plans to sell $1.4 billion of debt backed by payments under a legal settlement with tobacco companies and will seek approval from state lawmakers to borrow $3.7 billion to cover its pension contribution.
“It’s like the oil spill in the Gulf of Mexico because the money just keeps spilling,” said Miles White, chairman of Abbott Park, Illinois-based Abbott Laboratories, who is pushing the state to balance its budget as chairman of Civic Committee of the Commercial Club of Chicago. “We have to stop it.”
The state’s budget deficit combined with a glut of bonds may drive up its borrowing cost, said Gary Pollack, who helps oversee $12 billion as managing director of fixed income for Deutsche Bank AG’s Private Wealth Management unit in New York.
Today’s taxable sale may price at about 330 basis points above 30-year Treasury bonds, about 10 basis points narrower than indications yesterday, according to a person familiar with the preliminary pricing. The latest spread would be an 11 percent widening over Build America Bonds the state sold last month at 297 basis points above Treasuries. A basis point is 0.01 percentage point. Citigroup Inc. is managing the offering.
The average yield on Build America debt was about 199 basis points above 30-year Treasuries yesterday, according to a Wells Fargo index.
“Illinois has replaced California as the new example of fiscal malpractice for the muni market,” said Pollack. “They passed their budget, but there are still questions about the state’s pension funding.”
Illinois ended fiscal 2010 on June 30 “in the worst fiscal position in its history,” Comptroller Daniel Hynes said in a report. The state’s backlog of unpaid bills rose to $4.7 billion from $2.8 billion a year earlier, Hynes said. The state’s general fund balance fell to negative $4.7 billion, the lowest level in the state’s history. Hynes declined to comment through spokeswoman Carol Knowles.
Without the borrowing, the state would have to cut services too deeply, said David Vaught, Governor Pat Quinn’s budget director.
“You can’t afford to decimate the social safety net or fire all the two-year teachers,” meaning the most recent recruits, said Vaught in a phone interview. “You have to use strategic borrowing until times get better.”
The causes of the state’s deficit have been building for more than a decade as the state increased spending on Medicaid and other services and ignored its pension liabilities, said Vaught, who took over last year when Quinn came into office. Since 2006, total state spending has risen to $81 billion from $55 billion, according to comptroller records.
As revenue started to decline, deficits and the backlog of unpaid bills began rising as state officials failed to cut spending fast enough to balance the budget, said Jim Nowlan, a senior fellow at the Institute of Government and Public Affairs in Urbana, Illinois. At the same time the state has failed to keep up with funding its pension plan.
Corporate income-tax revenue fell 20.5 percent last fiscal year, while sales tax collections dropped 6.9 percent and personal income taxes declined 7.7 percent, Hynes said in the report.
“There’s no political will to do the right thing,” said Pat Brady, chairman of the Illinois Republican Party, which is the minority party. “It’s all about doing what is politically expedient.”
To address its budget crisis, state officials need to cut spending, especially by finding ways to reduce their commitment to employee pensions, said White, the Abbott chairman. Even if a commitment to cutting spending is demonstrated, they may still need to raise taxes to help eliminate the deficit, he said.
“The state’s budget has been mismanaged for years,” White said. “We’ve been spending more than we’ve been taking in and we’re borrowing to cover current costs, which is silly.”
Illinois will take the steps to cut and reallocate spending, Quinn said in an interview at the National Governors Association meeting July 10.
“I will navigate the state through the toughest budget it’s had in years,” he said.
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