Illinois Begins First Bond Sale as Worst-Rated U.S. State

Illinois sold $800 million of general-obligation bonds, its first offer since becoming Standard & Poor’s lowest-rated U.S. state.

The yield penalty on some debt was almost triple the levels achieved in a deal last month by California, with a credit grade one step higher. Bank of America Merrill Lynch bought the Illinois bonds, rated A-, sold via auction.

Illinois’s offer included $450 million of tax-free debt, with the portion maturing in April 2023 priced to yield 3.3 percent, data compiled by Bloomberg show. That’s about 1.33 percentage points above benchmark munis.

When California issued about $2.1 billion in tax-exempt debt last month, a 10-year segment priced to yield 2.56 percent, or 0.48 percentage point more than top-rated securities, Bloomberg data show. California has an A grade from S&P after earning an upgrade on Jan. 31, its first since 2006.

The results of the sales show the divergent outlooks for the two states in the $3.7 trillion municipal market.

California Governor Jerry Brown, a Democrat, has proposed a budget for the fiscal year beginning July 1 that will leave the most-populous state with a surplus. Meanwhile, lawmakers in Illinois have yet to pass measures to bolster the worst-funded state pension system. Democratic Governor Pat Quinn released a video in November showing a cartoon of “Squeezy the Pension Python” threatening to strangle the capitol building in Springfield.

Status Quo

“It’s a different credit situation -- California has definitely made some difficult steps,” said Robert Miller, who helps oversee $32 billion of munis in Menomonee Falls, Wisconsin, at Wells Capital Management. He said the company didn’t participate in the Illinois offer because the spreads were too narrow. “Illinois at this point is more of the status quo.”

Last month, the fifth-most-populous state settled with the U.S. Securities and Exchange Commission over assertions that it misled investors on the degree of underfunding for its retirement funds from 2005 to 2009 as it sold $2.2 billion in bonds. The settlement didn’t include fines or penalties.

Illinois has just 39 percent of assets needed to cover projected retirement obligations for five major groups of public employees, according to the Chicago-based Civic Federation, a nonprofit group that tracks government finance. The state’s pension-system shortfall is almost $100 billion, and rating companies have threatened the possibility of downgrades.

Penalty Notice

“Today’s rate is a direct result of the General Assembly’s failure so far to pass a pension reform bill,” John Sinsheimer, Illinois’s director of capital markets, said in a statement. “The state continues to pay a significant penalty for its failure to address the shortfall in its pensions.”

Illinois plans to sell another $1 billion of general-obligation debt this year for capital projects and may come back to the market as soon as May, Sinsheimer said in an interview. Passage of a pension-overhaul law would expedite the borrowing, he said.

The state postponed a $500 million offering Jan. 30, five days after S&P cut the rating on its debt to A-, six steps below AAA. Both S&P and Moody’s Investors Service give Illinois their lowest grade among U.S. states, with negative outlooks.

Illinois and its localities pay the highest interest rate of 19 states tracked by Bloomberg. Investors demand a yield penalty of 1.3 percentage points above AAA securities to own general-obligations from Illinois issuers. The spread is still close to the narrowest in two years as buyers seek extra yield to pad returns.

Borrowing Plans

The state’s decision to delay its January bond sale may have increased the interest rate it paid. Demand for tax-free state and local debt has waned in the past month as individuals sell for tax payments before the April 15 filing deadline.

Investors withdrew money from muni mutual funds for four straight weeks through March 27, the longest stretch since August 2011, Lipper US Fund Flows data show.

“We’re in a bit of a weak seasonal period right now,” Peter Hayes, head of munis at New York-based BlackRock Inc., the world’s biggest money manager, said before the sale. “Market demand itself was inherently stronger in January, so they may have actually gotten tighter spreads and certainly better absolute yields if they had come in January.”

Illinois’s bonds mature from 2014 to 2038 and proceeds will pay for road, rail and school projects. Bank of America Merrill Lynch beat out eight other banks for the debt.

The state increased the deal size from January because more initiatives were ready to get under way as the construction season begins, according to Abdon Pallasch, an assistant budget director.

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