Illinois may jump into the market with its $1 billion long-term general obligation bond deal as soon as Wednesday.
Late Tuesday, syndicate members on the negotiated issue were told that the state was preparing to enter the market and to join a call with the state and its financial advisors set for early Wednesday morning. A pre-pricing wire was to be distributed ahead of the call, according to sources.
Illinois has two sales on the day-to-day calendar. A $1.2 billion issue of one-year general obligation certificates that will help cover a fiscal 2020 shortfall in tax revenues due in part to the tax filing extension. That deal, which must be sold competitively under the state’s short-term borrowing statutes, was initially set for last week.
The $1 billion of taxable and tax-exempt GOs for capital and to fund an ongoing pension buyout was initially targeted for a Tuesday sale with BofA Securities running the books.
Syndicate members on the $1 billion negotiated deal were asked Monday for “pricing views” and firms sent out notices to potential buyers that the state’s taxable portion could see a “possible Wednesday pricing depending on market conditions.” Gov. J.B. Pritzker’s administration has said that the certificates would sell first and did not respond to a request for comment Tuesday on timing.
Pritzker during his daily briefing on the state’s response to the COVID-19 pandemic was asked about the delay in the certificates sale. Pritzker said the delay on the bond issues was about “simply working with the underwriters to make sure they've got the right pricing and do it in a way that will affect the state in a positive way” and that the deals would be completed.
The market will be watching closely for how steep a spread penalty the state faces as there's much speculation over pricing premiums, the state's timing on the issues and whether the state is looking at the Federal Reserve's Municipal Liquidity Facility short-term lending program. Illinois is qualified for $9.7 billion in financing and Chicago for $1.5 billion.
The state’s 10-year yield was at 5.28% Tuesday, a 415-basis-point spread to the Refinitiv Municipal Market Data’s AAA benchmark and its one-year was at 4.27%, a 373-basis-point spread.
The 10-year rose to 415 from 396 basis points late last week and pricing talk last week put the long-term bond rate in the 7% range. Some market participants were predicting this week rates between 6% and 7% but there’s little consensus on the subject.
The state could be better served by going ahead and selling the bonds first, some market sources said. Too steep a penalty imposed on the short-term deal would set a bad tone for the long-term bonds and also would raise questions over why the state had chosen to forgo use of the MLF if it offers lower rates. Pritzker’s administration insisted last week that it was not considering use of the MLF given the requirement that the certificates must be sold competitively and it borrows only what it needs.
Some market participants disagreed. Illinois should consider holding off on any long-dated borrowing to avoid the stain associated with peak yield penalties and should take advantage of the Fed’s MLF program, Vikram Rai, Citi’s head of municipal strategy said Monday.
Rai believes the market will further stabilize and that would help narrow Illinois spreads by more than 100 basis points by the summer. Rai has long been bullish on the state citing the many levers available to the state and flexibility to address its fiscal challenges and strong economy.
However, a rate in the 7% range would “become a high-water mark,” Rai said in an interview. “That mark is hard to erase. It gets etched into investor psyches. Illinois would do itself a disservice to price any bonds at this exorbitant level.”
The state’s 10-year opened April at a 298 basis point spread. The 10-year rose steadily through April to 366 basis points in the second week, 381 in the third week and closed out the month at a 391 spread. The 10-year in the state’s last primary outing in the fall landed at a 140 spread.
Spreads rocketed over the course of April as the state warned of a $2.7 billion revenue shortfall in the current fiscal year and another $4.6 billion hit in fiscal 2021 due to the economic shutdown imposed to slow the spread of the COVID-19 pandemic. The state also took one downgrade and two outlook cuts, leaving it at the BBB-minus and negative level across the board.
Illinois’ spreads ballooned over a “trifecta of bad news,” Rai said. The market priced in worries over an eventual downgrade to junk. It also factored in the overhang of the planned bond deals and talk sparked by Senate Majority Leader Mitch McConnell about letting states file for Chapter 9 bankruptcy protection, even though market participants believe the legal, constitutional, and legislative hurdles translate into almost insurmountable hurdles.
While Illinois bonds may eventually rally some damage will have been done with that peak borrowing penalty remembered the next time the state or market face turmoil.
“It’s the number you remember. Even now, investors remember the budget deadlock,” Rai said. At the height of the deadlock in June 2017, with its investment grade on the line, the state’s 10-year spread hit what was then a peak of 335 basis points and it reverberated across the market.
A delay in the long-term borrowing would buy time for market stabilization that will be helped as the Fed's MLF program gets up and running, creating a “gravitational pull” that will impact the overall curve.
Market technicals, fund flows and liquidity all could improve due to such factors as summer redemptions. “I’m expecting better conditions,” Rai said.
The federal government also could act on a new relief package that makes up for state and local government’s lost revenue. Pritzker said Tuesday he expects a deal in the next two to three weeks.
Pricing guidance released Monday on the MLF program that is not yet formally up and running would assign a roughly 4% rate for Illinois based on the an overnight index swap rate and spread of 380 spread tied to the state’s ratings, Rai said. The state has access to more than $9 billion under the facility with a term of up to 36 months.
The expected rate is better than it can achieve in the market, traders said.
Legislative authority likely would be needed to use the MLF and that’s no easy task given that Illinois lawmakers have not set a next meeting date and need to approve a fiscal 2021 budget with an up to $7 billion COVID-19 related revenue gap to close unless the federal government does so in the next expected relief package.
Even if the state eventually moves forward with a public sale of the certificates, Rai said release of the pricing guidance could help the state’s sale as it shows the market the state has access to lower rates. The state also should still pursue legislative authority to use the MLF as a potential means to refinance other, higher-cost debts, such as some overdue bills that carry up to 12% interest rates.
Rai and others had hoped that the long-awaited pricing guidance would offer an attractive alternative for issuers, but it’s clear that the Federal Reserve’s intends to serve only as a last-ditch backstop.
“But it still makes sense for Illinois to utilize the facility,” Rai said. “It’s an emergency facility for a liquidity crunch. This is a liquidity crunch.”
The Fed created the $500 billion MLF in early April and it has yet to go into effect. While the program is intended to help issuers otherwise denied market access, the term sheet allows issuer participants to consider pricing. “Lack of adequate credit does not mean that no credit is available. Lending may be available, but at prices or on conditions that are inconsistent with a normal, well-functioning market,” regulations read.
