Illinois Bond Cost Lowest Since ’09 Shows Stability: Muni CreditBrian Chappatta
Illinois obtained the lowest borrowing cost since 2009 in its latest general-obligation deal, a sign that investors expect the state’s credit rating to stabilize after seven downgrades in four years.
The state sold $250 million of tax-free bonds yesterday, with a 10-year portion yielding 3.42 percent, or 0.93 percentage point more than benchmark municipal debt, data compiled by Bloomberg show. That’s the lowest yield spread since Illinois borrowed in September 2009 with a Standard & Poor’s grade three steps above the current A-.
Illinois faces a “critical juncture” in the next 50 days that will determine the direction of the lowest-rated U.S. state’s fiscal health and credit standing, S&P said this week. Investors have gained confidence after Democratic Governor Pat Quinn endorsed extending an income-tax increase and as lawmakers moved to address Chicago’s pension burden, said Duane McAllister, a money manager at BMO Asset Management Corp.
“If this tax increase becomes permanent and they make the tough decisions here in the next few weeks, most likely they’ll go to a stable outlook,” said McAllister, who helps oversee $4 billion of munis in Milwaukee, Wisconsin. “Then maybe the spreads we’re seeing on Illinois will be justified.”
The general-obligation sale was Illinois’s third since lawmakers passed a bill in December to repair the worst-funded U.S. state pension system.
The lower borrowing cost will save taxpayers $10 million over the life of the bonds as Illinois builds roads, schools and bridges, Abdon Pallasch, assistant budget director, said in a statement yesterday. It suggests that Illinois may follow the path of California, which resorted to IOUs in 2009 and is now poised for its best S&P rating in five years.
Yesterday’s offer coincided with Greece ending a four-year exile from international markets to issue more bonds than the government anticipated.
Illinois, which had S&P’s third-highest rating before the recession began in December 2007, is now graded four steps above speculative grade. Moody’s and Fitch give it negative outlooks. S&P calls it developing, meaning fiscal conditions could either improve or deteriorate depending on lawmaker actions. It hasn’t had a stable outlook since January 2013.
Decades of pension shortchanging and political inaction pummeled Illinois’s standing among investors. Its pensions were 40.4 percent funded as of 2012, the weakest among states, Bloomberg data show. Lawmakers in December broke the gridlock by approving retirement-system changes designed to save $145 billion over 30 years.
The passage didn’t bolster the fifth-most-populous state’s rating, as the credit companies cited legal challenges to the pension overhaul and the expiration at year-end of a temporary personal-income tax increase. The boost in 2011 to 5 percent from 3 percent was the largest in Illinois history.
The state’s Democratic-led legislature passed the increase in January 2011 to help close a $13 billion budget deficit. A roll-back would create a shortfall of about $2 billion in fiscal 2015. Quinn last month proposed keeping the higher rate.
The governor’s plan, combined with December’s pension bill, “provides a floor to the ratings and at least for now keeps them out of BBB,” the lowest investment-grade category, said Eric Friedland, head of muni credit research in New York at Schroder Investment Management North America. The firm oversees about $4 billion in local debt.
The legislature proved its willingness to act on pension legislation this week. Lawmakers approved Chicago’s effort to stabilize two of its four pension systems about a month after Moody’s cut the city to Baa1, three steps above junk.
The state’s yield spread was too narrow to attract BMO and Schroder, McAllister and Friedland said. The rate was the third-lowest since Quinn took office in 2009, Pallasch said.
Illinois sold as benchmark yields approached the lowest since June. While that decline helped, “much of the improvement also is owed to the market’s approval” of Quinn’s latest budget plan, John Sinsheimer, the state’s director of capital markets, said in yesterday’s release.
The sale follows general-obligation borrowings of about $1 billion in February and $350 million in December. Yield spreads on those deals fell 26 percent and 29 percent, respectively, from similar offers in 2013, Bloomberg data show.
Illinois bonds are beating this year’s muni rally, gaining 4.5 percent through April 9, to the market’s 4 percent gain, S&P Dow Jones Indices data show. The extra yield on Illinois debt remains higher than any of the 17 U.S. states tracked by Bloomberg, even though it has narrowed 36 percent from October.
“The tightening has been swift,” Friedland said. While political debate over taxes could spark volatility, “if you look a year from now, I expect them to be tighter,” he said of the state’s yield spreads.