Competitive Illinois GO deal brings narrower spreads

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Illinois’ $750 million general obligation issue proved an easy sell for broker-dealers as worries about the state’s finances took a backseat to demand for higher yielding paper.

The state competitively sold the bonds in three tranches, two for $300 million and one for $150 million. The 10-year bond landed at a yield of 2.92%, a 140 basis point spread to Municipal Market Data-Refinitiv’s AAA benchmark set at the market close Tuesday.

Photographer: Johnny Knight

The state is still paying a steep penalty as the 10-year yield represents a 78 basis point spread to the BBB benchmark.

Illinois GOs are the weakest rated among states at BBB/Baa3/BBB-minus from Fitch Ratings, Moody’s Investors Services, and S&P Global Ratings but the ratings have stabilized with a budget — balanced on a cash basis — adopted in the spring.

The state's budget and finances have long been tenuous but the deal was the first since a conservative policy group and New York-based hedge fund filed a lawsuit challenging repayment of $14.3 billion in state GO debt. The judge denied the petition but an appeal is expected.

Illinois landed better spreads Wednesday than in its most recent sale in March and better than recent trading levels. MMD had the state’s 10-year at a 161 bp spread ahead of the sale.

The sale results Wednesday prompted MMD to move the Illinois curve on maturities 10 years and out to 150 bps from 161 bps.

The most comparable bond, a nine-year maturity, in a spring sale came at a 178 bp spread. MMD Wednesday moved the nine-year spread to 145 bps from its previous setting at 159 bps.

“There’s a supply and demand imbalance in new issue yield and yield products and Illinois is clearly one of larger issuers of yield product so it received ample attention from the buyside,” said Adam Buchanan, senior vice president on the institutional sales and trading desk at Ziegler.

The use of a competitive sale might have aided the state as bankers saw it as an opportunity to step up as they vie for future negotiated issuance expected under the state’s $45 billion capital program, several market sources said. The state must sell 25% of its annual issuance competitively and that includes its first deal of the fiscal year.

The state’s extra yield stood out, several traders said, amid a crowded $12.9 billion slate of deals this week that marked the biggest calendar of the year.

Maturities beginning in 2033 offered 4% coupons.

Barclays won over nine other bidders on the $300 million series that offered maturities from 2020 to 2029 with a true interest cost of 2.6058%.

Bank of America Merrill Lynch won the $300 million series with maturities from 2030 to 2039 with its 3.5786% TIC over seven other bidders and it won the $150 million that offered maturities from 2040 to 2044 with a TIC of 3.8057% over 10 other bidders.

Cover bids were tight indicating the deal sold on the market based on demand, traders said.

“The State of Illinois is very pleased to have received such a strong response from the municipal bond market,” said the state’s director of capital markets, Paul Chatalas. “We were pleased to have entered the market near historic low interest rates and with solid investor demand, and the results reflect a low all-in interest cost.”

The deal marked the first new money borrowing to help fund the six-year, $45 billion infrastructure program enacted during the legislature’s spring session.

While the low-drama passage of a budget passage under first-year Gov. J.B. Pritzker and stable ratings have helped the state’s spreads, the deal is the first since the lawsuit challenging $14.3 billion of Illinois GO debt.

The state’s secondary market spreads had shrunk to a low of 139 bps on the 10-year in late spring and early summer but then shot up to about 175 bp in July after the lawsuit’s filing. A judge in late August denied the petition to file as a taxpayer action. The policy group has said it intends to file an appeal this month or early next month.

The state’s spreads have fluctuated in recent years. The 10-year in an August 2018 deal landed at a 175 bp spread. That deal sold after the state’s two-year budget impasse ended. The 10-year in the previous deal that sold in the fall of 2016 amid budget gridlock came at a 192 bp spread.

Secondary market spreads hit a high as the state headed toward a third fiscal year without a budget in June 2017 of 273 bp. After passage of a budget in July 2017, spreads have steadily narrowed, aside from the post-lawsuit blip.

The “Rebuild Illinois” capital plan passed with bipartisan support ended a long drought in new capital spending. The plan relies on nearly $21 billion in borrowing, $10 billion in federal funds, $11 billion in pay-as-you-go financing, and $2.6 billion in local matching funds. Various new and higher taxes will help fund the program, including a doubling of the state’s motor fuel tax.

The state recently warned in its five-year forecast that its structural deficit will swell to more than $3 billion in five years, driving the state's unpaid bill backlog up to a record $19 billion from the current $6.9 billion. Pritzker is banking on passage of a constitutional amendment next year shifting to a progressive income tax from the current flat rate requirement to raise $3 billion in new annual revenue. Unfunded pension liabilities rose last year to $137 billion from $134 billion and the state is carrying a $6.6 billion bill backlog.