Illinois bond default looking more remote

Bonds from Illinois, the second lowest-rated U.S. state, are yielding less than issues from comparably rated Portugal as the state prepares to market its largest taxable municipal debt sale in more than seven years. Next week Illinois is selling $3.7 billion of taxable debt to investors around the world after the end of the Build America Bonds program left the municipal market with pent-up demand for such securities. The offering will likely see increased interest from international and crossover buyers, said Richard Ciccarone, managing director of McDonnell Investment Management LLC in Oak Brook, Illinois, which holds more than $7 billion of muni debt. “Non-traditional investors are going to be tempted to jump in,” Ciccarone said, referring to investors who typically buy taxable assets such as Treasuries and corporate bonds. “There is a spillover benefit from the BABs. It provides another investor base to the market.” Illinois, which is selling A+ rated general obligations to fund its pension, is facing a budget deficit of as much as $15 billion. Its four-year bonds traded yesterday at a 4.40 percent yield. Comparable bonds from Portugal were yielding 6.15 percent, Bloomberg data show. The country, which has the euro- region's fourth-largest budget deficit, has raised more than 4 billion euros ($5.5 billion) this year selling securities through auctions and private placements as the nation seeks to avoid resorting to international aid. Portugal's deficit trails Ireland and Greece, both of which stopped raising debt through bond markets last year and turned to the European Union and the International Monetary Fund for bailouts after borrowing costs became unsustainable. Income Taxes Illinois last month boosted income taxes 67 percent to help close its budget deficit, an act that has “resonated” with international investors, said John Sinsheimer, the state's director of capital markets. The state has marketed the bonds in eight cities across Europe and Asia in the last two weeks, he said. “We got very good reception,” Sinsheimer said. “I expected significant offshore interest.” The size of the sale and the relative dearth of taxable issuance since the Build Americas expiration “makes it a bit more attractive,” he said. Illinois issued $10 billion in taxable pension bonds in 2003. Taxable issuance last month was $959 million, compared with $11.1 billion in January 2010. “It would have been, not impossible, but they really would have had to pay a significant premium if they hadn't raised taxes prior to issuing to debt,” said Howard Cure, director of municipal research for Evercore Wealth Management LLC in New York, which has about $2.6 billion of assets under management. Illinois Shortfall Illinois is at least $6 billion short of closing a budget gap. When the Legislature approved the 67 percent personal- income tax increase and a 46 percent boost in the corporate- income tax on Jan. 12, those levies were projected to produce about $6.8 billion annually, according to the Governor's Office of Management and Budget. That's less than half the amount needed to close a fiscal budget shortage that former Comptroller Dan Hynes said in an October report may exceed $15 billion. Democratic Governor Pat Quinn's response has been to borrow more. Quinn asked lawmakers to approve an $8.75 billion bond sale to pay off accumulated unpaid bills of at least $6 billion. “This took 28 years to create, or more, and it's probably going to take about 14 years to pay the debt restructuring off,” Quinn said in a Jan. 25 news conference in Chicago. Credit Rating Credit-rating companies reaffirmed the state's general- obligation bond ratings in January. Moody's Investors Service said in a Jan. 24 report that the tax increases and other moves taken by the state are a “major step toward beginning to address Illinois's chronic budget imbalances.” Moody's, which also kept a negative outlook on the credit, said the state still faces “significant challenges,” including higher debt levels and a backlog of unpaid bills. The state House rejected a similar borrowing proposal Jan. 11 that was part of the tax-increase package. Republicans criticized the bonding authorization, saying there needs to be budget cuts. That argument has carried over into the new legislative session. “There wasn't enough budget cutting to go along with the tax increase,” said Doug Whitley, president and chief executive officer of the Illinois Chamber of Commerce. “The key element right now is what will Governor Quinn's full-year 2012 budget look like?” “He's got to show more fiscal restraint or there will be a significant backlash to the tax increase,” Whitley said. Partial Solution Tom Johnson, president of the non-partisan Taxpayers' Federation of Illinois, said the Legislature solved only part of the problem last month. “They are better off short term,” Johnson said in a telephone interview. Unresolved, he said, is the cost of underfunded state pensions. Perceived risk of the state's debt has fallen about 27 percent this year, Bloomberg data show. Insuring $10 million of Illinois debt against default cost $260,000 a year yesterday, down from $357,910 a year on Jan. 6. The cost of insuring corporate debt from BellSouth Corp., rated two levels below Illinois, was just $31,060 yesterday. “They're going to pay a penalty for their slow movement in addressing some of their basic weaknesses,” Ciccarone said. Still, “a lot of investors will be attracted since yields on investment-grade corporates are relatively low compared to what they can get on Illinois.” --Bloomberg News--