Biggest Pension Gap Fails to Deter Illinois Buyers: Muni Credit

Illinois had to turn away buyers from a $1.3 billion sale of general-obligation bonds even after lawmakers failed twice in the past month to fix the nation’s weakest state pension system.

The fifth-most-populous state lowered yields from initial levels after receiving more than $9 billion in bids, said Democratic Governor Pat Quinn. After the $3.7 trillion municipal market lost about 5 percent this month in the biggest decline since 2008, investors saw a buying opportunity, said Dan Toboja at Ziegler Capital Markets.

“People were keeping their powder dry for Illinois,” said Toboja, vice president of muni trading at the Chicago-based broker. The state “got lucky with timing,” he said.

Illinois’s issue yesterday came at a cost: Uninsured debt due in July 2023 was priced to yield 4.46 percent, or 1.53 percentage points more than benchmark munis, data compiled by Bloomberg show. That penalty is up 19 percent from an issue of tax-free debt in April. Quinn said legislative inaction on pension bills in sessions on May 31 and June 19 added $130 million to borrowing costs.

Payment Confidence

Investors can have confidence that the lowest-rated U.S. state won’t default for the first time since the 1840s, said Marc Joffe, principal consultant at San Francisco-based Public Sector Credit Solutions.

The probability of default is zero “under any plausible budget scenario,” according to a report released yesterday by Joffe, whose firm provides data and analysis related to municipal securities.

Buyers still require a larger yield cushion to lend to Illinois as lawmakers have let the state’s unfunded pension liabilities swell to $97 billion. The funding level of 43 percent is the worst among U.S. states, Bloomberg data show. Illinois also faces a backlog of $6 billion in unpaid bills.

After lawmakers left Springfield, the capital, May 31 without passing a pension fix, Fitch dropped Illinois on June 3 to A-, the fourth-lowest investment grade. Three days later Moody’s cut it to A3, the equivalent rank. Standard & Poor’s has the state at the same level.

Session Failure

Quinn, 64, called a special session for June 19 following the Moody’s cut. No pension measures passed. The governor has called a special session to deal with pensions -- the third in less than a year -- for July 9.

“Legislative inertia has a price,” the governor said in a statement. “As I’ve warned repeatedly, this is an emergency.”

A legislative conference committee is scheduled to hold its first public hearing today in Chicago to fashion a compromise pension bill. State Senator Kwame Raoul, the panel’s chairman, said in a statement that “the final product won’t be anyone’s ideal outcome.”

Investors have also penalized Illinois bonds in the secondary market.

The extra yield on taxable Illinois pension debt maturing in June 2033 relative to Treasuries has risen 0.54 percentage point this month, Bloomberg data show. That’s the biggest increase since August 2011.

Enticing Yield

The biggest portion of Illinois’s sale was $260 million of uninsured bonds maturing in July 2038. The debt was priced at a yield of 5.65 percent, equivalent to a 9.4 percent taxable yield for buyers in the highest federal income-tax bracket.

“There was plenty of enticement in terms of yield for those who were willing to take the risk,” said Richard Ciccarone, chief research officer at Oak Brook, Illinois-based McDonnell Investment Management LLC, which oversees $8 billion in munis. “These don’t happen very often, where you’re that wide on a state G.O. to the rest of the marketplace.”

Proceeds from the sale will go toward projects such as rebuilding the Chicago Transit Authority’s Red Line train. Some segments of the sale were backed by Assured Guaranty Municipal Corp.

Los Angeles joined Illinois in selling yesterday. The city issued $1.3 billion of notes maturing within a year, according to a press release from the city administrative officer.

Even though 71 deals this week are listed as day-to-day, states and cities are still poised to sell about $8.6 billion of long-term debt, the most since April, Bloomberg data show.

Illinois’s sale came as 10-year AAA munis yield 2.93 percent, close to the highest since April 2011. The interest rate compares with 2.54 percent for similar-maturity Treasuries.

The ratio of the yields, a gauge of relative value, is about 115 percent, the highest since July. The greater the figure, the cheaper munis are compared with federal securities.

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