CHICAGO — Illinois will remarket floating-rate paper in a direct placement set for Nov. 7, resolving a potential strain that expiring letters of credit posed for its already stressed balance sheet.
The state disclosed the transaction late Tuesday in a supplement to its offering statement on a $1.35 billion general obligation refunding sale set for Thursday. The state will return next week with $480 million in a competitive sale.
The resolution for the expiring LOCs on its $600 million of floating rate debt from a 2003 issue followed Illinois' renegotiation of five interest rate swaps, which included the novation of two. They are tied to the 2003 bonds that represent the only floating-rate exposure in the state's $26 billion GO portfolio.
The state was able to lower the ratings thresholds that triggered termination events, giving the nation's lowest-rated state some breathing room before it hit the triggers.
The state's revised swap agreements were first disclosed in the offering statement published Sept. 30. Gov. Bruce Rauner's administration hired Swap Financial Group and Katten Muchin Rosenman LLP earlier this year to work on easing the liquidity risks.
That left the LOC issue to resolve.
Six letters of credit provided by JPMorgan Chase, PNC Bank, Wells Fargo Bank, State Street Bank, Royal Bank of Canada, and Northern Trust currently support the bonds. All expire on Nov. 27.
“The Rauner administration has reduced the taxpayers' financial risk by successfully negotiating replacements for the letters of credit inherited from the prior administration,” said Rauner spokeswoman Catherine Kelly. “This action is more favorable to taxpayers and provides the state with more flexibility to prioritize spending for social services, education and our state's most vulnerable.”
Under terms of the new direct placement, the bonds will bear either a LIBOR or SIFMA-based interest rate with a mandatory tender date of Nov. 7, 2018. In the event of a failed remarketing, the bonds will "amortize more quickly than their original stated amortization schedule, and will bear interest during that amortization period at a significantly higher interest rate than the interest rate would otherwise apply," the OS supplement says.
The state anticipates entering continuing covenant agreements that closely mirror current terms. The banks were not named.
Under the current LOCs, the state pays a 2.85% fee that increases to 3.35% if one of its ratings drops to BBB-minus.
After a Sept. 30 downgrade, S&P Global Ratings has Illinois at BBB with a negative outlook. Moody's rates the state Baa2 with a negative outlook and Fitch Ratings assigns a BBB-plus rating and has it on negative watch.
If the state falls to junk the fee increases to 5.35%. "Should Illinois fail to extend the LOCs, the bonds have a three-year term out at a higher interest rate," S&P wrote in its downgrade report.
The five swaps are with four counterparties and bear an interest rate of 3.89%. They are negatively valued at $153 million. Barclays is counterparty to two swaps each for $54 million, Bank of America on $54 million, JPMorgan Chase on $54 million, and Deutsche Bank on $384 million.
Following negotiations that began in April, the state negotiated revised terms that lowered its rating trigger. It also novated two swaps with Barclays assuming the swaps previously held by Merrill Lynch Capital Services Inc. and AIG Financial Products Corp.
Terminations are triggered at junk level on the Barclays, JPMorgan, and BofA swaps while the trigger is set one notch lower on the Deutsche Bank swap.
The Rauner administration said at the time the state entered into the swaps they cost the state 4.16% in interest and fees while the cost is now 6.79% in interest and fees.
Resolution of both issues provides some rare positive news for the state as it heads into a crowded market with its largest deal in several years with an S&P downgrade fresh on investor minds.
The state remains locked in a budget impasse, it's carrying a deficit of $5.4 billion, its bill backlog is $8.7 billion and growing, while its unfunded pension liabilities are $113 billion.
Demand remains strong especially for higher yielding paper which could hold the state's penalties in check but it's a hard call, say market participants.
"Supply has been heavy and it's a large transaction. It's one to watch as there hasn't been a lot of trading because no one wants to get out in front of the deal. Buyers are waiting to see where the market resets on Illinois," said one Chicago-based trader.
Matt Fabian, partner at Municipal Market Analytics, said the deal's timing isn't helped by the added supply in the market as issuers rush to act ahead of the election and possible rate changes. Money markets have also shed holdings in the secondary market ahead of the Oct. 14 effective date on regulatory imposed money market reforms.
"In general, it's still a strong market but that being said it's the most unstable it's been in maybe a year," Fabian said. "It makes Illinois bonds a much less compelling buy because you have many alternatives. Normally bigger is better because it implies better liquidity. That's not the case for Illinois and it's going to harder to corral enough investors at an aggressive price."
It helps that the deal is negotiated and that lawmakers approved a bill to free the deal from the state's stringent structuring rules.
That allows the underwriting team more structuring flexibility on maturities and coupons.
Bank of America Merrill Lynch and Jefferies are running the books.
On its most recent GO sale in June, the state saw spreads of about 185 basis points to the Municipal Market Data top-rated benchmark but it had narrowed since to a between 160 and 170 basis points.
In the investor presentation, budget director Tim Nuding acknowledges the state's struggles.
"Illinois has now gone 15 months without a full year general revenue fund budget," he said.
Rauner, a Republican, and the General Assembly's Democratic leaders agreed to a stopgap budget plan this summer with the goal of getting through the November election when they believe it will be easier to settle their differences.
"We hope that has created trust….and serves as a good foundation on which to move forward after the election," Nuding said.
The state's last billion-dollar sale was in February 2014 when it carried A level ratings.
