Illinois Losing to California Shows Pension Penalty

Illinois’s biggest debt sale in 11 months showed lawmakers aren’t working quickly enough to make up ground the state lost to California in the eyes of investors.

Buyers awaiting progress on plans to overhaul the worst-funded state pension system demanded about 1.33 percentage points of extra yield above benchmark munis for 10-year tax-exempt debt that Illinois sold yesterday. That’s almost triple what California had to pay last month.

In sales about a year ago, the Illinois yield penalty was only double that of the most-populous state. Since then, Standard & Poor’s has cut Illinois twice, to A-, six steps below AAA, as legislators failed to advance a pension fix. Meanwhile, the company raised California’s credit for the first time since 2006, to A, one level higher, after Governor Jerry Brown, a Democrat, proposed a budget for the year beginning July 1 that would leave the state with its first surplus in almost a decade.

“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 buy the Illinois offer because the spreads were too narrow. “Illinois at this point is more of the status quo.”

Recess Wait

In the Illinois legislature, politicians in both chambers advanced measures last month to help fix the state’s pensions before a recess that is set to end next week. The House plan would cut Illinois’s unfunded liabilities by $20 billion immediately and save $100 billion over 30 years, according to Democratic Representative Elaine Nekritz.

“The state continues to pay more for its bonds than it would if the General Assembly passed pension reform,” John Sinsheimer, Illinois’s director of capital markets, said in an interview after the sale. “Investors would like to see bills land on the governor’s desk.”

The state 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 pension-system shortfall is almost $100 billion, and annual costs are projected to grow by more than $900 million in next year’s budget.

Python Pitch

To raise public awareness of the pension burden, 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.

“They have some proposals in the legislature, but nothing has been put into law yet,” Miller said. “To us, that doesn’t mean credit quality has changed.”

The state postponed a $500 million offering Jan. 30, five days after S&P cut the rating on its debt. Both S&P and Moody’s Investors Service give Illinois their lowest grade among U.S. states, with negative outlooks. Fitch Ratings grades California one step lower than Illinois, at A-.

Illinois’s $800 million general-obligation sale yesterday included $450 million of tax-free debt, with a 10-year portion priced to yield 3.3 percent, data compiled by Bloomberg show. That’s about 1.33 percentage points above benchmark munis. In California’s $2.1 billion tax-exempt issue last month, 10-year bonds yielded 0.48 percentage point more than benchmark securities.

2012 Comparison

A year ago, California issued bonds at a spread of 0.84 percentage point for 10-year debt, compared with a gap of 1.73 percentage points for Illinois about two weeks later.

The Land of Lincoln is still benefiting from demand for lower-rated debt in the $3.7 trillion municipal market. It will pay a so-called true interest cost of 3.92 percent on the borrowing, matching the 20-year low set in January 2012, according to a release from Abdon Pallasch, an assistant budget director.

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

Proceeds of Illinois’s sale will pay for road, rail and school projects. Bank of America Merrill Lynch beat out eight other banks for the debt, which was offered via auction.

Bigger Deal

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

Pennsylvania today will offer the week’s biggest muni borrowing, a $950 million general-obligation deal set to price through competitive bid. States and cities are poised to issue $6.1 billion of long-term debt this week, the slowest non-holiday week since February, according to Bloomberg data.

Munis have cheapened relative to Treasuries since mid-March as investors sell city and state bonds to raise cash before the April 15 federal tax-filing deadline.

At 1.97 percent, yields on 10-year muni benchmarks compare with 1.86 percent on federal debt. The local-bond interest rate has exceeded that on Treasuries since March 13, the longest stretch since September.

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