Bond prices in Florida have stayed firm in the face of a fiscal 2016 budget impasse that could trigger a government shutdown, while Chicago is having a tougher time weathering the storm that drove the Windy City to junk status last week, municipal traders said.
The Florida market has been slower to react after Gov. Rick Scott's warning to state agencies last week to prepare lists of "critical" state funding needs in the event the impasses lead to a July 1 shutdown.
Chicago bond prices have weakened and spreads remain wider by at least 50 and upwards of 100 basis points compared to the Municipal Market Data scale, nearly a week after Moody's Investors Service led a barrage of downgrades, traders said.
The battered credit has a challenging road ahead, they said, as the city reached forbearance agreements with banks and set plans to convert $800 million in floating-rate general obligation paper to fixed rate on Wednesday, with Bank of America Merrill Lynch running the books.
The Illinois market is still seeing wider spreads, higher yields, and a swell in bid-wanted lists from investors reluctant to own anything related to Chicago or Illinois, traders said.
"In Illinois, yield levels have risen on a wide variety of credits in the state in which the general public is worried about negative repercussions with pensions or state aid," said Richard Ciccarone, president and chief executive officer at independent research and data provider Merritt Research Services.
"The average investor makes generalizations based on guilt by association, thereby avoiding these credits altogether," he added.
Most Illinois paper had already cheapened, and spreads widened significantly over the last month, according to an Illinois trader.
Spreads on some credits even surged to as wide as 300 basis points above MMD's top-rated benchmark on May 15 when Fitch Ratings - prompted by Moody's downgrade of the city to junk -- lowered Chicago one notch to BBB-plus and placed it on negative watch.
Standard & Poor's on May 14 lowered Chicago two notches to A-minus and placed it on CreditWatch with negative implications.
Both downgrades were prompted by liquidity risks stemming from Moody's decision on May 12 to lower $8.9 billion of Chicago GOs, sales tax, and motor fuel bonds by two notches to the speculative grade level of Ba1, with a negative outlook, after the Illinois State Supreme Court ruled the state's pension reforms were unconstitutional.
Since then, trading activity is down, the Illinois trader said.
"In general, it's a holiday week so it's quiet, but with Illinois it's just ugly," he added.
By contrast, in Florida, trading is largely business as usual.
"We haven't seen anything creep into wider territory across the board yet," a Florida trader said on May 20. "State paper and even COPs have been holding in pretty firm," he said.
For instance, state GO bonds due in 2016 were bid at a price of $109.302 and yield of 0.642% on May 1, and two weeks later on May 15 they were bid at $109.113 and a yield of 0.652%, according to Markit.
State GOs due in 2030, meanwhile, were bid at $102.782 and a yield of 3.493% as of May 1, and on May 15 were bid at a price of $101.943 and a yield of 3.642%, the price evaluation service reported.
Florida's current budget delays have been less publicized compared to Chicago's pension problems, and the state GOs and other credits have benefited from recent price stability and strength, the Florida trader noted.
He said some investors are either misinformed, immune to, or tuning out the "constant battle" on budget issues, like Medicare, between Florida's Senate and House of Representatives.
We have been in a recovery," he said, noting that in general the state GOs have tightened to 15 basis points and the certificates of participation have tightened to 65 basis points compared to the MMD scale.
The state GO spread is near its all-time tightest and underscores its current strength - in spite of the budget turmoil, the Florida trader noted.
"There is no effect of people pricing in any weakness" due to the possible shutdown, he said.
However, spreads were wider on the Florida Citizens Property Insurance Corp.'s $1 billion of fixed-rate bonds and floating-rate notes.
According to MMD, the 2025 maturity with a 5% coupon priced to yield 3.20% was 88 basis points cheaper than the comparable scale at the time of the May 20 pricing.
The Florida trader said spreads were likely wider due to the extremely large size of the deal and its arrival ahead of a holiday week.
Should the budget battle heat up in coming weeks, spreads on Florida paper in general could widen beyond the current levels, he said.
"The appropriation-backed bonds could be seen as a credit worry," if the COP credit widens to 75 basis points of more versus the MMD scale.
The state GOs trading at 20 basis points or more would indicate noticeable weakness, he added.
Meanwhile, traders don't expect the stormy skies over Chicago to clear anytime soon.
It will be hard for the market to ignore its junk rating, a secondary trader at a North Carolina firm said. "This is as cheap as I've seen it in 20-plus years," he added.
The deal's delay from the original plan to come to market on May 19 was a big red flag, traders said, and they expect the situation to get worse before it gets better.
The city still has to deal with its $20 billion in unfunded pension liabilities, they noted.
The downgrades also made nervous investors more wary, as traders said many of the city and state's bonds are being arbitrarily painted with the same brush - even if they are higher rated than the GO itself.
"Typically, borrowers associated by state or type with serious problem credits are usually penalized by any commonality among them," Ciccarone explained.
The North Carolina trader agreed. "Illinois names period are going to trade wider just because of what's going on in the state and with the city of Chicago," he said.
Skittish retail investors on May 20 put a noticeable amount of paper out for bid, including city GOs, Board of Education, and water revenue bonds, as they are eager to liquidate bonds from the trouble city and state ahead of further credit deterioration, he said.
Some bid-wanted lists showed customers selling blocks as large as $5 million, he noted. The price deterioration has been swift, traders said.
Prices on Chicago GOs with a 5.25% coupon due in 2021 and callable at a par in 2018 traded fell to $100.21 as of May 15 from $104.775 on May1, and the yields rose to 5.16% from 3.35% over the same time, according to Markit data.
"They weren't this wide a few weeks ago," the North Carolina trader said of the Chicago GO spreads to MMD.
Ciccarone said some of that weakness can be investor-induced.
"More sophisticated investors may demand higher yields because of the shrinkage in demand for bonds that may have common elements of the problem credit in the headlines -- even if the name appears to be in satisfactory shape on its own merits," he explained.
Headline risk surrounding borrowers such as Chicago, Illinois, New Jersey, Puerto Rico is one of three "storms" converging on the municipal bond market, J.R. Rieger, global head of fixed income at S&P Dow Jones Indices, said in a May 19 report.
Headline risk, heavy supply ahead of a holiday week, and the potential impact of rising rates on the fixed income market, amount to a "powerful trio of bad news" for the municipal market, he said in the report.
Reiger said the combination has put a heavy weight on the investment grade, tax-free bond market, which has seen negative returns in 2015, he added. The S&P National AMT-Free Municipal Bond Index is down 0.73% month-to-date and 0.36% year-to-date.
The S&P Municipal Bond Illinois General Obligation Index is down 2.63% month-to-date and is the worst performing GO index, according to the report. Chicago GO bonds comprise 35% by market value of the index, which is down 3.06% year-to-date.
"There hasn't been this much effect in [weakness] trickling down to Chicago names in a while," the Illinois trader said.
"They are going to have to do something to calm to the market," he said of city officials' efforts to gain more control over pricing scales and create acceptable, court-approved alternatives to its pension crisis.
When the Chicago deal prices, the indicators of renewed market acceptance will be demand and the level of yields, the Chicago trader said.
"In Illinois, yield levels are normally a little higher than other states since there are few bonds with double tax exemption," Ciccarone explained. But, he noted, the current scenario is making matters worse.
"The fiscal crisis in Illinois only boosts yields even more," he said.
The Florida trader agreed that a general trend of credit weakness can often unfairly cast related bonds in a poor light.
"Non-related issues can get pulled into that and get caught up in the momentum," he said.
