Struggling Illinois eyes $900m bond sale

Struggling Illinois eyes $900m bond sale
By Nicole Bullock in New York and Hal Weitzman in Chicago
Copyright The Financial Times Limited 2010
Published: July 13 2010 18:23 | Last updated: July 14 2010 01:18
http://www.ft.com/cms/s/0/61801b5c-8ea0-11df-8a67-00144feab49a.html


The cash-strapped state of Illinois on Wedesday will set terms for a bond sale as it seeks to borrow $900m in a test of investor appetite for troubled US local issuers.

States and municipalities, which raise money in the $2,800bn municipal bond market, have come into the spotlight after several years of budget deficits and worries about global public finances.

“The state of Illinois is currently the poster child for all the market concerns about the state budget deficit and inadequate public pension funding in the US,” said Triet Nguyen, a municipal bond trader at Ziegler, a Chicago-based broker dealer.

Illinois has nearly $5bn in unpaid bills and its pensions system is funded at about 50 per cent, the worst ratio of the 50 states. Its inability to tackle these fiscal problems in its latest budget led to credit ratings downgrades and a rise in the cost to insure its debt against default to the highest for any US state.

The legislature passed a partial budget last month before handing over responsibility to Pat Quinn, Illinois’ governor, to balance the books.

Mr Quinn made $1.4bn cuts, most of which fell on programmes for the physically and mentally disabled, as well as schools and universities.

The governor also bet on savings from “operational efficiencies”, and issued an executive order to cut costs on a range of state spending from travel to magazine subscriptions.

However, much relies on delaying tackling the state’s fundamental financial problems. Rather than doing anything to address the backlog of unpaid bills, the budget contained a plan to extend the time the state has to pay from September to December.

Mr Quinn plans to borrow up to $4bn to pay the state’s pension fund contribution. He also proposes taking $1bn from special state funds and using the proceeds of a national tobacco settlement.

The $900m bonds are being sold under the Build America bonds (Babs) programme that allows for a federal subsidy for debt sold for infrastructure. The aid means that Illinois can sell a type of bond that has broad appeal and officials for the state and underwriter Citigroup aggressively marketed the bonds in Europe and Asia as well as the US.

Most “munis” are tax-free in the US, making them attractive only to local investors.

The state can offer investors comfort in that bond payments are the top priority bill, which means they are paid before other expenses. Illinois has issued $7.5bn of debt since January.

“Whenever you sell bonds you want [investors] to know you’re going to pay those bonds no matter what,” said Lynnae Kapp, a bond analyst at the Commission on Government Forecasting and Accountability, the non-partisan auditing arm of the Illinois state legislature.

Even so, investors are demanding a significant premium, or spread, to US Treasuries, on the latest sale, about 340 basis points for bonds due in 2035. Average spreads on Babs are 233 bps, according to an index from Barclays Capital.

Investors have been diversifying away from troubled areas of the US, sending yields on some bonds higher and others to multiyear lows.

The state’s unpaid bills amount to $4.7bn, up from $2.8bn at the same point last year. The delays have affected agencies such as the Child Abuse Council in Rock Island, western Illinois, which depends on state grants and contracts for three-quarters of its funding.

Pam Hauman, the organisation’s director of programs, said that if the state waits until December to pay what it owes, “it could decimate us – we still have to continue to pay staff to provide services”. In the next few weeks the council, which helped 4,000 people last year, will have to decide whether to cut jobs and services.