Illinois Pension Impasse Predicted in Penalty Jump: Muni Credit
Illinois borrowing costs are headed for the biggest monthly increase since May 2012 as investors bet two rating cuts won’t be enough to spur lawmakers to fix the worst-funded U.S. state pension system.
The extra yield bond buyers demand on the state’s taxable debt has jumped 0.25 percentage point this month, data compiled by Bloomberg show. The rising borrowing costs and credit reductions this month from Moody’s Investors Service and Fitch Ratings are the backdrop for a special session set for today. It’s the second called by Democratic Governor Pat Quinn in 10 months after lawmakers failed to deal with a $97 billion unfunded pension liability before leaving the capital May 31.
Even as lawmakers prepared to convene, they acknowledged the likelihood of failure. Democratic leaders are moving to create a conference committee to develop a compromise, said Rikeesha Phelon, spokeswoman for senate President John Cullerton. The governor will call another special session next month, according to his spokeswoman, Brooke Anderson.
“Investor confidence for the state has been diminishing,” said Joseph Gankiewicz, a credit analyst in Princeton, New Jersey, at BlackRock Inc., which oversees $114 billion of munis. “They’ve had multiple chances to address this.”
Illinois’s five state pension systems had 43 percent of assets needed to cover obligations in fiscal 2011, the lowest ratio among U.S. states, Bloomberg data show. Quinn, 64, has said coming up with a fix “has confounded legislatures and governors for 70 years.”
Pension funding is a nationwide challenge. American localities face more than $2 trillion in unfinanced retirement obligations, according to Moody’s Investors Service.
Detroit, the insolvent Michigan city about 300 miles (480 kilometers) east of Chicago, plans to cut pension benefits for 30,000 workers and retirees as it tries to avert a record municipal bankruptcy. It defaulted on muni debt for the first time last week.
Benefits are at the heart of the Illinois stalemate. House Speaker Michael Madigan’s pension plan is designed to save $187 billion over 30 years. It would require state pensioners to pay more for their retirement, an approach that Cullerton said violates the state’s constitution. Cullerton proposed giving employees a choice of pension or health-care reductions that would save an estimated $50 billion.
The Chicago Democrats haven’t come up with a compromise, resulting in the impasse.
Illinois is rated four steps above junk by Standard & Poor’s, Moody’s and Fitch, the lowest among states. Taxpayers may be hit by the consequences of legislative inaction as soon as next week, when the state plans to issue $1.3 billion of general-obligation bonds, its biggest sale since May 2012.
Eric Friedland, head of muni research in New York at Schroder Investment Management North America, said he’s “not expecting any miracles to occur in one day.” The company oversees about $2 billion in munis, including Illinois debt.
Now isn’t a good time to buy Illinois bonds because the $3.7 trillion municipal market is on pace to decline for a second straight month, and because of volatility in the state’s debt after the rating cuts, Friedland said.
When Illinois lawmakers failed to pass a pension fix in January, the state postponed a $500 million debt sale following an S&P downgrade. This month’s offering will go on as planned regardless of the legislature’s actions, said Abdon Pallasch, the state’s assistant budget director.
“Failure to pass pension reform is going to cost Illinois taxpayers more,” Pallasch said by telephone. “If the general assembly were to take action, that would really help with the sale.”
The prospect of pension measures reaching Quinn’s desk spurred a rally in the state’s debt last month. The yield penalty on taxable Illinois pension bonds maturing in June 2033 dropped by 0.45 percentage point in May after both chambers passed bills. That was the biggest rally in at least three years.
Instead, legislators left Springfield, the capital, May 31 without reaching a compromise, causing the spread on the pension bonds to widen this month.
“It is an equal-opportunity, bipartisan mess,” U.S. Senator Richard Durbin of Illinois, the chamber’s second-ranking Democrat, said in an interview. “We’re in bad shape. We’ve got to bust out and get this done.”
Durbin said the legislature should send the dueling bills from Madigan and Cullerton to the state supreme court to determine their constitutionality.
“Why don’t you make the Madigan option tested constitutionally, and if his doesn’t meet the constitutional test, then the default position is Cullerton’s,” Durbin said.
Cullerton and Madigan have been unable to use veto-proof Democratic majorities in the senate and house to forge a compromise. Even with a governor of the same party, the three most powerful leaders in Springfield haven’t been able to agree on a solution.
The pension squabble is increasingly complicated by electoral politics.
Quinn faces a challenge in the March primary from former White House Chief of Staff Bill Daley, brother of former Chicago Mayor Richard M. Daley. State Attorney General Lisa Madigan, daughter of the house speaker, is also considering running.
“In this horse race, the odds are not in favor of them getting it done in this session,” said Richard Ciccarone, chief research officer at Oak Brook, Illinois-based McDonnell Investment Management LLC, which oversees $8 billion in munis. “We’ll see if they can surprise us.”
In the municipal market this week, issuers such as Dallas-Fort Worth International Airport plan sales as yields are close to a 15-month high.
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