(Bloomberg) -- Less than two weeks after Illinois lawmakers
broke through decades of gridlock and passed a bill to bolster the worst-funded
U.S. state pension system, taxpayers are already seeing the benefits.
The state sold $350 million of taxable general-obligation
bonds yesterday to pay for work on roads, bridges, schools and public
transportation. Debt due in December 2038 priced to yield 5.65 percent, data
compiled by Bloomberg show. The 1.84 percentage points of extra yield above
benchmark Treasuries was almost a third less than in a comparable sale in
April, Bloomberg data show.
The 29 percent reduction from eight months ago saves more
than $20 million over the life of the securities, according to Abdon Pallasch,
assistant budget director for Illinois, which has the lowest credit grade among
states. Standard & Poor’s signaled this week that the accord on retirement
costs could trigger a ratings increase.
“The market recognizes that this is a clear improvement and
that the credit risk of the state is diminished as a result of this pension
action,” said Chris Mier, chief municipal strategist at Loop Capital Markets in
Chicago.
California Model
Illinois’s role model for regaining favor in the $3.7
trillion municipal market may be California, with an S&P credit grade one
step higher. The Golden State had its bond ranking raised by S&P and Fitch
Ratings this year after voters approved tax increases that produced a projected
budget surplus. California’s bonds rallied this year to the most expensive
levels since 2008.
Underfunded public pensions have prompted changes in states
from California to New York. Since the recession ended in 2009, three-quarters
of states have curbed costs through steps such as requiring public employees to
pay more into pension funds or cutting benefits for new workers, according to
the National Association of State Retirement Administrators.
In Illinois, the proposal passed last week would limit
annual cost-of-living allowances and raise the retirement age for some workers.
The plan projects $160 billion of savings over the next 30 years.
The agreement extended a two-month rally in tax-exempt
Illinois bonds. The extra yield investors demanded on general obligations due
in 10 years instead of AAA munis fell to 1.58 percentage points on Dec. 11, the
lowest since August.
April Comparison
In yesterday’s sale, the yield spread on the taxable bonds
due in December 2038 compared with a gap of 2.6 percentage points above
Treasuries on 25-year debt from the April deal.
The taxable bonds were issued via competitive sale, with a
unit of Bank of America Corp. winning the bid, Bloomberg data show. The
Charlotte, North Carolina-based company also bought the taxable general
obligations in April, the data show.
Zia Ahmed, a spokesman at Bank of America, declined to
comment on the result of the sale.
S&P was the only rating company to alter its outlook on
the state following the pension bill’s passage, and said the rating could move
higher or lower depending on the law’s implementation. The company cited the
risk that the changes could be declared unconstitutional or invalid, or be
delayed.
Five Failures
Before last week, legislators had failed five times since
August 2012 to pass a pension solution, pushing Illinois’s yield penalty to the
highest among 17 states tracked by Bloomberg. In comparison, bonds of states
with top ratings, such as Georgia and Maryland, trade even with or below
benchmark munis. California’s premium is about one-fifth of Illinois’s.
“While it comes as good news that the state of Illinois is
not paying as big of a penalty for its financial instability, Illinois is still
paying more than it should to borrow when compared to other more stable and
better-rated states,” said Laurence Msall, president of the Civic Federation, a
Chicago- based nonprofit research organization that specializes in government
finance.
Illinois was among five states where retirement-funding
ratios fell at least 21 percentage points from 2007 to 2012, data compiled by
Bloomberg show. The fifth-most-populous state’s funding level fell to 40.4
cents on the dollar, from almost 63 cents in 2007, Bloomberg data show. Its
retirement systems face $100 billion in unfunded liabilities.
Risk Remains
“The risk is the market may overshoot credit improvement,
and that’s a pattern we’ve seen with other state G.O.s,” said Eric Friedland,
head of municipal credit research in New York at Schroder Investment Management
North America, which oversees about $4 billion in local debt. “Over the next
couple of months, there could still be some volatility.”
Governor Pat Quinn, a Democrat, said in a statement last
week that the pension measure “is very helpful in our discussions with the
rating agencies and the bond buyers who purchase the issuances of the state.”
The municipal market is wrapping up almost $13 billion of
long-term debt sales this week, the most in three years, Bloomberg data show.
The volume pushed yields to a three-month high.
Benchmark 10-year munis yield 2.99 percent, close to the
highest since mid-September, compared with 2.88 percent on similar-maturity
Treasuries.
The ratio of the interest rates, a gauge of relative value,
is about 104 percent, compared with a five-year average of 102 percent. The
higher the figure, the cheaper munis are compared with federal securities.
Source: financial-planning.com
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