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Illinois Rally Defies Warning of Pension Insolvency: Muni Credit

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Former Chairman of the U.S. Federal Reserve Paul Volcker
A group headed by Paul Volcker, seen here, and Richard Ravitch said in a report that the state’s pensions are “destined for insolvency” and may absorb a quarter of the state’s budget in 2015. Photographer: Peter Foley/Bloomberg

Oct. 29 (Bloomberg) -- Debt sold by Illinois issuers is rallying the most in 20 months in the face of a warning that the state’s pensions may run out of money and drain funding from education, infrastructure and local aid.

Investors seeking to enhance returns amid the lowest municipal interest rates in a generation shrank the extra yield on bonds of Illinois and its localities to 1.43 percentage points last week, the least since February 2011, data compiled by Bloomberg show. The yield spread relative to AAA tax-exempts is still the highest among 19 states tracked by Bloomberg.

Debt-holders in the lowest-rated U.S. state by Moody’s Investors Service are willing to take the risk because of their confidence in getting repaid. Illinois is one of seven states with the strongest legal provisions for paying debt service on its general obligations, according to Fidelity Investments.

“You would think the state would be penalized for its lower rating, but I believe people look at its statutory requirement to pay debt,” said Michael Belsky, head of muni research at SF Investments Inc., which oversees about $500 million in Highland Park, Illinois. “Before they pay the governor, build a highway or fund a prison, they have to pay debt service first.”

Growing Appetite

Illinois joins lower-rated issuers in the $3.7 trillion muni market benefiting as sinking yields spur investors to stomach more risk. Near-junk hospital debt has rallied the most in four years just months before potential Medicare cuts. The yield penalty for California, rated one step above Illinois by Moody’s, is close to the slimmest since 2008.

Investors got the latest reminder of Illinois’s fiscal challenges last week. A group headed by Paul Volcker and Richard Ravitch said in a report that the state’s pensions are “destined for insolvency” and may absorb a quarter of the state’s budget in 2015.

The fifth-most-populous state’s retirement system had 43.4 percent of assets needed to cover promised obligations in 2011, the weakest among the 50 states, data compiled by Bloomberg show.

Two months ago today, Standard & Poor’s cut the state’s credit one level to A, sixth-highest, citing retiree costs, and gave it a negative outlook. Moody’s downgraded the debt in January to A2, also sixth-highest.

Failed Session

State lawmakers failed to advance any measures in a special session called by Democratic Governor Pat Quinn on Aug. 17 that sought to address $83 billion of unfunded pension liabilities.

“The culture of budget gimmickry and short-sightedness pushes costs off to the future, but eventually that will be impossible -- retirees may lose their pensions as the funds dwindle,” the State Budget Crisis Task Force wrote in last week’s study. Volcker, a former Federal Reserve chairman, and Ravitch, a former lieutenant governor of New York, are co-chairmen of its advisory board.

Richard Ciccarone at McDonnell Investment Management LLC said the state’s pension deficit and backlog of $8 billion in unpaid bills mean its fiscal prospects may deteriorate further.

“They’ve got a long way to go to prove themselves,” said Ciccarone, chief research officer at Oak Brook, Illinois-based McDonnell, which oversees about $8 billion in munis. “It’s very hard to feel that their interest in correcting these problems will lead to a solution without a crisis.”

‘Miniscule’ Risk

Some investors still can’t get enough Illinois bonds “because they’re cheap, and the risk of non-payment is miniscule,” said Matt Fabian, a managing director at Concord, Massachusetts-based research firm Municipal Market Advisors.

The state has also had some cause for fiscal cheer. Its revenue has grown 2.9 percent in the fiscal year that started July 1, beating the state’s 1.8 percent estimate, according to MMA. The boost comes in part from the temporary increase in personal-income taxes that Quinn pushed for in 2011.

Highlighting the appeal of higher-yielding securities, interest rates on local debt held close to 45-year lows last week. Twenty-year general-obligations yielded 3.68 percent, after touching 3.6 percent in January, the lowest since 1967, according to a Bond Buyer index.

The state pays its debt service by allocating money to its General Obligation Bond Retirement and Interest Fund, according to John Sinsheimer, Illinois’s director of capital markets. At the end of each month, it adds enough cash to cover one-sixth of semiannual coupon payments and one-twelfth of all principal payments.

Only South Carolina, Minnesota, Utah, Missouri, Texas and Virginia have safeguards that are equal to or better than Illinois’s, according to a Fidelity report released in May 2011. No state has missed payments since Arkansas in 1933.

Following are pending sales:

CONNECTICUT plans to sell $400 million in general-obligation bonds as soon as this week, data compiled by Bloomberg show. About $220 million will taxable securities. (Added Oct. 29)

THE TRUST FOR CULTURAL RESOURCES OF THE CITY OF NEW YORK, which sells debt on behalf of museums and non-profits, plans to issue $112.5 million of revenue bonds as soon as this week, data compiled by Bloomberg show. The Wildlife Conservation Society will use the proceeds to help finance a building for sharks and other sea creatures at the New York Aquarium in Coney Island. The deal will also fund renovations at the Bronx Zoo and refinance debt, according to offering documents. (Updated Oct. 29)

To contact the reporter on this story: Brian Chappatta in New York at

To contact the editor responsible for this story: Stephen Merelman at

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