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Illinois’s Surging Debt Yields Lure Buyers in Market Test

Danielle Moran

(Bloomberg) -- Illinois sold $800 million of debt, its first borrowing since the coronavirus exacerbated the worst-rated state’s fiscal woes, showing that its access to the capital markets remains intact even as investors demanded large yield penalties to buy the securities.

Bonds maturing in 2045 sold at a 5.85% yield, nearly four percentage points above top-rated benchmark debt, according to data compiled by Bloomberg. That’s slightly under the 5.95% yield initially offered, according to preliminary wires viewed by Bloomberg, yet still more than double the penalty on its last sale in November, when debt due in 2044 priced at 159 basis points over benchmark.

Even before the virus hit, the state had been grappling with $134 billion of unfunded pension liabilities and more than $6 billion of unpaid bills. Illinois’s challenges have only worsened as businesses shutter and more than a million residents rely on unemployment benefits. The Democrat-run state has been held up as an example by Republicans, including President Donald Trump, as one not worthy of federal budget aid, drawing unwanted attention just as it was turning to the bond market to raise cash.

“This is what every other lower-rated issuer or state, the Connecticuts, the New Jerseys, or anyone that has been waiting a little bit -- this is a very good sign for them,” said Nisha Patel, a portfolio manager at Parametric Portfolio Associates LLC. “That the lowest rated state with a lot of speculation of losing their investment grade rating, the deal like this getting done, with this type of subscription signals to other issuers that the water is warm, you can come into the market and get a decent size issue done.”

The yield penalty investors are requiring shows how dramatically the coronavirus pandemic has affected investors’ views of Illinois’s bonds. Prices on previously issued bonds have tumbled sharply since March amid speculation that the steep economic slowdown may turn it into the first state to be stripped of its investment grade rating.

“The results of today’s offering demonstrates strong demand for Illinois bonds from the investment community, even in a fragile market and uncertain environment,” said Paul Chatalas, Illinois’s director of capital markets in a statement. He said the deal received orders from more than 120 investors. The proceeds will go toward funding capital projects and to help cover the state’s ongoing pension buyout program.

“Based on the economic environment and the pressures that creates in lower revenue collections, we are in a world where risk has been repriced and people are demanding more yield for the unknowns,” said James Iselin, a portfolio manager at Neuberger Berman Group LLC, which has about $11 billion in municipals under management, including outstanding Illinois bonds.

State forecasters have cut their estimates for Illinois’s general-fund revenue in the year ending June 2021 to $36.4 billion, down $4.2 billion from a March projection. Governor J.B. Pritzker said last month the state is expected to face a $6.2 billion shortfall for the next fiscal year because of the virus. That gap could expand to $7.4 billion if voters don’t approve his proposed graduated income tax hike.

The state had planned to sell $1.2 billion in short-term bonds through a competitive auction on May 6 to ease the revenue shortfall in the last two months of the fiscal year. That sale has been placed on “day-to-day” status, meaning it will be sold if market conditions warrant. The state said in a statement Wednesday that it still intends to issue the securities and is prepared to enter the market at any time.

“We’ll be continually accessing the public markets as states always do,” Pritzker said Wednesday. “But we were very pleased by the strong showing, strong interest, in the bonds that Illinois sold today.”

The ability for Illinois and the Metropolitan Transportation Authority, which sold bonds last week, to clear deals is a sign that the market is “healing” after March’s record retreat, Iselin said.

“Six weeks ago, I don’t think anyone would have said that Illinois or the MTA could come to market,” he said. “Slowly but surely the market is coming back.”

(Adds governor’s comments in 11th paragraph)

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