Illinois rode the tailwinds of market demand for higher-yielding paper and its rosier fiscal picture that sent its spreads to a primary outing low not seen since 2014.
Investors scooped up the state's bonds Tuesday, initially submitting $16 billion of orders for the $1.26 billion of general obligation paper as the underwriting team led by Morgan Stanley moved the sale up a day.
That allowed Illinois to avoid the potential for market turbulence Federal Reserve Chairman Jay Powell’s comments might stir up in his news conference Wednesday that follows the Federal Open Market Committee two-day meeting.
The state said it had received strong enough order interest in the pre-marketing wire distributed Monday that it decided to accelerate the sale which drew “more than 700 orders from more than 130 different investors, including respected names that have not invested in the state for a decade,” the state’s Director of Capital Markets Paul Chatalas said in a statement.
Given the state’s vulnerability to headlines, “pricing ahead of the next headline” if orders have lined up is a wise move, said Matt Fabian, partner at Municipal Market Analytics. The supply calendar is also on the rise and that can impact interest.
A confluence of factors helped the sale, from the return of inflows and demand for higher-yielding paper to the state’s improving tax projections and a looming infusion of $7.5 billion from the $1.9 trillion American Rescue Plan signed by President Biden last week.
“Illinois again has the great good fortune of borrowing when rates are low, and spreads are tight. There is a lack of muni supply, and that was illustrated by the order book here,” said Brian Battle, director of trading at Performance Trust Capital Partners.
Gov. J.B. Pritzker’s proposed fiscal 2022 budget also lacks any red rating flags by making a scheduled pension payment and holding the line on spending. The positive momentum prompted
Proceeds will finance capital building projects, technology investments, an ongoing pension buyout program, and refund existing debt. The true interest cost of the three series was 2.90% and the refunding achieved $21.8 million, or 8 %, present value savings.
The pre-marketing wire offered prices slightly cheaper to where the state’s bonds were trading on the mid to long end but by the final award late Tuesday, the state had wiped out that concession and spreads settled at lower levels on mid- to long-term maturities and in line on the short end to recent trading levels.
“The preliminary spreads, in general” were “within 10-15 basis points off where we had IL GO priced to begin today and that does not strike me as a lot of concession considering the size of $1.26 billion,” said Greg Saulnier, managing analyst for U.S. Municipal Bonds at Refinitiv.
The state’s one-year bond settled at 0.69%, a 63 basis point spread to Refinitiv MMD’s AAA benchmark. The 10-year landed at 2.22%,120 basis point spread, and the 25-year bond at 2.75%, a 115 basis point spread. All came with 5% coupons.
At those levels, the state’s spreads on its 1-,10-, and 25-year bonds are down to 20, 39, and 31 basis points over the BBB benchmark. The state’s ratings are at BBB-minus and Baa3.
The pre-marketing rates Monday represented spreads of 80, 135, and 140 on the 1- ,10-, and 25-year bonds, respectively. They narrowed by five basis points in the initial pricing wire Tuesday and drew such strong interest that a repricing further cut yields.
Overall, the spreads shrunk by 17 basis points on the one-year, 15 basis points on the 10 year, and 25 basis points on the 25-year from pre-marketing levels to the final wire.
Overall the deal was oversubscribed by eight times, but it was the long bonds that saw the healthiest demand and were oversubscribed by 18 times. Some maturities offered a 4% coupon, catering to buyers who prefer the cash flow coming faster and premium price protection.
“The size of the deal broadens the appeal and the timing — coming so closely after the enactment of the American Rescue Plan and the certainty of federal aid — helps to bolster the comfort level with the credit,” said Patrick Luby, senior municipal strategist at CreditSights Inc.
Spread History
The
Illinois hit a new primary peak in May 2020 of 456 basis points on its 10-year and 400 on its 25-year bond as the market viewed the state’s investment grade under threat due to the pandemic. A November 2020 deal saw spreads narrow to 268 basis points and271 basis points on the 10- and 25-year.
Tuesday's results were Illinois' lowest spreads Pat Quinn was governor in 2014. That was before the state’s two-year budget impasse that began in 2015 under Gov. Bruce Rauner, a Republican, who repeatedly clashed with the legislature’s Democratic majorities.
The state saw a 122 basis point spread on the 10-year in a May 2014 deal and 113 basis points on its long 23-year bond in the deal. The state did not issue debt in 2015 and going forward spreads only widened as the state’s ratings fell and the gridlock continued.
In January, June, and November 2016 deals, spreads on the 10-year and long bonds ranged from 154 basis points to 203 basis points. In a December 2017 sale after the impasse ended with lawmakers approving a budget and income tax hike over Rauner’s objections, the 10-year saw a 170 basis point spread and the 25-year 162 basis points.
Spreads during 2018 outings ranged from 177 basis points to 203 basis points on the 10- and 25-year bonds.
Pritzker beat Rauner out of a second term and took office in January 2019. Political peace helped keep spreads in check with the 10-year in an April deal settling at 178 basis points. There was not long bond. A November 2019 deal saw spreads of 140 and 160 basis points on the 10- and 25-year bonds.
Fitch Ratings, Moody’s Investors Service and S&P rate the state at BBB-minus or equivalent, the lowest investment grade level. All three moved their outlooks to negative at the start of the pandemic and Fitch and Moody’s maintained it in their latest reports.
Near versus long-term views
Long-term strains led by a $141 billion pension tab remain burdensome as Pritzker has said he would prioritize using much of the federal money to pay down $3 billion in outstanding Municipal Liquidity Facility borrowing and overdue bills, but those concerns were pushed to the backburner Tuesday.
“Free money always helps but there has been very little fundamental changes to the state of Illinois current financial situation and there’s no plan/adjustments/discussions/or strategy for the long-term structural imbalances,” Battle said.
The deal’s results underscore the benefits of the upcoming federal aid. “The federal money reduces the risk that they make a bad decision so that helps stabilize” the rating in at least the near term but upward momentum beyond the state’s outlook seems unlikely until long-term strains like pensions are eased and that will take spending cuts and/or more revenue, Fabian said.
Ahead of the sale, CreditSights placed a market outperform rating on the state’s GO paper as the wide spreads don’t reflect the state’s sovereign powers that provide amply abilities to pay its debt and given the infusion of federal dollars there’s room for spreads to tighten.
“Given the lack of additional spread pickup out the curve, we prefer to stick to shorter maturities,” authors John Ceffalio, senior municipal research analyst, and Luby wrote in a report published Monday.
Market participants will be watching closely to see how the state uses the federal dollars.
“A cautious approach, focused on retrenching, paying down liabilities, and spending one-time windfalls only on one-time uses could pave the way for steady credit improvements,” CreditSights said. “A decision to use the one-time influx of cash to create ongoing funding commitments would likely keep the state pinned in the BBB category ‘penalty box’ for years to come.”
And the structural and pension woes will remain. “We continue to believe the state will need new revenues to maintain its pension funding plan and to balance its budget, however the state now appears to have more time before difficult choices are again required,” CreditSights said.
Cabrera Capital Markets LLC, JP Morgan, Siebert Williams Shank & Co. LLC and Stifel served as co-seniors. Columbia Capital Management LLC and Swap Financial Group advised the state.
