Bond Dearth Defied With Illinois’s Third 2014 Offer: Muni Credit

The smallest wave of municipal borrowing in three years is proving a boon for Illinois. The lowest-rated U.S. state is selling debt for the third time since February after winning the lowest bond costs since 2009.

In 39 states, an austerity push is helping keep issuance behind the 2013 pace, fueling the biggest muni rally in five years, data compiled by Bloomberg show. That’s not the case in Illinois, where localities have tapped falling borrowing costs to sell $4.5 billion of debt, the fastest pace since 2011.

Illinois’s $750 million offering tomorrow follows a deal two weeks ago in which the state’s yield spread shrank 16 percent from February. It will push the state’s borrowing in 2014 to $2 billion. Nationwide, municipalities have sold the least since 2011, even with benchmark interest rates close to a 10-month low.

“It’s an issuer’s market, particularly for weaker credits,” said Burt Mulford, who helps oversee $1.9 billion of munis at Eagle Asset Management in St. Petersburg, Florida. “Illinois is taking advantage of the fact that there is this appetite for yield. I would think the deal would go very well.”

Advantage Overlooked

Yields in the $3.7 trillion municipal market have fallen in 2014, defying forecasts that interest rates would rise for a second straight year. At 2.39 percent, yields on 10-year AAA munis are near the lowest since June, Bloomberg data show.

States and cities have been slow to capitalize on shrinking borrowing costs, even as the era of local budget cuts may be ending. Property-tax collections nationally reached about $183 billion during the fourth quarter, when much of the money is due, according to a Census estimate. That topped the peak four years earlier.

“We’re seeing a hangover from the austerity that gripped state and local governments during the Great Recession,” said James Dearborn, head of munis in Boston at Columbia Management Investment Advisers, which oversees about $30 billion in local debt. “It takes a while for them to get back into the mode where they’re going to be expanding their capital project lists.”

Illinois has led in debt sales even as it lags behind the nation’s economic rebound. Proceeds from this week’s deal will fund Illinois Jobs Now!, a $31 billion initiative started in 2009 to generate 439,000 jobs and improve roads, bridges and schools.

Bottom Three

The jobless rate was 8.4 percent in March, lower than only Rhode Island and Nevada, Labor Department data show. The national rate was 6.7 percent. Comptroller Judy Baar Topinka said in January that unpaid bills, which tallied $7.6 billion at year-end when including state agencies, will probably swell.

Moody’s Investors Service and Fitch Ratings have kept negative outlooks on Illinois in part because of the bill backlog and an income-tax increase that expires at year-end.

Yet investors have rewarded Illinois since lawmakers passed a measure to address the worst-funded U.S. state pension system in December. The extra yield buyers demand on Illinois debt has declined to 1.15 percentage points, the lowest since at least January 2013, Bloomberg data show.

The drop has saved taxpayers more than $90 million in borrowing costs over the state’s last three bond sales, according to Abdon Pallasch, Illinois’s assistant budget director.

April Deals

The fifth-most-populous state’s most recent deal was April 10, when it issued $250 million of tax-free bonds via auction. The 10-year portion yielded 0.93 percentage point more than benchmark munis, the lowest gap since a borrowing in September 2009.

“The pricing on the deal we did was very good, and we want to follow up accordingly,” John Sinsheimer, the state’s director of capital markets, said last week in an interview.

Two general-obligation sales in such a short time span is unusual for municipalities, Bloomberg data show. In 2010, Illinois issued Build America Bonds on Jan. 28 and then sold tax-exempt securities on Feb. 19.

Investors are watching the Illinois legislature for signs that politicians will extend the income-tax increase, Dearborn said. Democratic Governor Pat Quinn, who is up for re-election this year, last month proposed keeping the higher rate.

Quinn’s Plan

The Democratic-led legislature passed the boost in January 2011 to help close a $13 billion budget deficit. Lawmakers increased the personal-income tax rate to 5 percent from 3 percent, the largest jump in state history. A roll-back would create a shortfall of about $2 billion in fiscal 2015.

Bruce Rauner, the private-equity executive who is the Republican nominee for governor, calls Quinn’s plan “the ultimate broken promise” and vows to end the income- and corporate-tax rate increases.

Standard & Poor’s rates Illinois A-, six levels below AAA. The company said this month that the state’s fiscal stability is approaching a pivotal point, with the remaining weeks of the General Assembly’s budget session helping to determine its financial direction.

The legislature “seems to be on board with continuing to solve its problems because it is costing every municipality money each time they borrow, whether it’s state of Illinois, Chicago or any other,” said Duane McAllister, who helps oversee $4 billion of munis at BMO Asset Management Corp. in Milwaukee, Wisconsin.

“All the cards are on the table -- that’s the positive I see in Illinois,” he said.

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