Illinois governor pitches investors on state’s newly minted single-A paper

Gov. J.B. Pritzker promoted Illinois’ fiscal progress and ratings upswing in a direct pitch to investors as the state tees up its first general obligation bonds to carry single-A-level ratings since 2016.

The state plans to enter the market as soon as Wednesday with the $2.45 billion issue but with supply heavy this week and rockier market conditions at the start of the week the decision remains fluid, officials said.

The pre-marketing wire distributed Tuesday offers the one-year at a spread of 95 bps, the 10-year at 125 bps, and a 2047 maturity at 135 bps with the 2048 offered at a higher spread but with a lower coupon. That’s wide to where the state’s bonds have been trading in the secondary market on the short end, in-line with the 10-year and narrower on the long end.  

S&P Global Ratings in February raised the state’s rating to A-minus with a stable outlook from BBB-plus. Moody’s Investors Service in mid-March upgraded the state to A3 and stable from Baa1. Both rewarded the state for building reserves and paying down debts with surplus tax revenues.

Fitch Ratings followed in late March, lifting the state’s outlook to positive from stable on its BBB-plus rating, signaling the potential upgrade, possibly soon after passage of a fiscal 2024 budget that makes further progress on chronic fiscal strains. 

While Pritzker boasted of the state’s eight rating upgrades during his tenure, he acknowledged during an investor meeting in New York Monday that “just to become an average credit state in the United States we have work to do, but we are on our way. I think we’ve proven over the last four years that we’ve made tremendous progress.”

Pritzker, a Democrat, met with investors after taking office in 2019. He won re-election November.

Illinois remains the lowest-rated state but “the rating upgrades open up Illinois to a new universe of buyers,” said one major investor who holds Illinois GO paper and will participate in the deal if the yields meet his firm’s internal valuations.

Separately managed accounts that restrict their holdings to A-level credits are among the potential new buyers, while mutual funds and other institutional investors that have limits on how much Illinois paper they can hold at the BBB level can now add to their holdings, buyside sources said. Even risk-adverse buyers may look more favorably on Illinois, but whether they put in orders remains to be seen.

“It’s reasonable that we won’t see downgrades in the next few years, so some investors will be more comfortable,” the investor source said.

Illinois lost its single-A-level ratings from Fitch and Moody’s in October 2015 and S&P followed in June 2016, so an early 2016 GO sale was the last to carry at least one A-minus rating. The three rating agencies have handed the state a series of upgrades over the last two years, moving it from the brink of a junk rating, where the state landed during its two-year budget impasse during former Gov. Bruce Rauner’s term.

The pitch
The state expects to keep chipping away at its accounts payable — formerly known as the bill backlog — bringing it down to about $1.4 billion compared to $8 billion in 2019. The state has shed its short-term debts, but has $26 billion of outstanding GOs.

The state has built the rainy-day fund to an expected level of $1.9 billion at the close of fiscal 2023, compared to $60,000 in 2019, and has seen modest improvement in pension funding ratio which was at 44.1% for fiscal 2022.

In addition to statutory contributions, the state made $500 million in supplemental contributions in the last budgets and the proposed fiscal 2024 budget calls for a $200 million additional payment. The pension liabilities remain the state’s most burdensome strain at $139 billion.

The funded ratios, at least on a market value basis, are also expected to fall this year — although the actuarial valuations smooth the impact of returns over five years — with three of the funds seeing a 1.2% return through February, the largest fund that covers teachers returning 4.4% through January and the universities’ fund returning 2.9% through January. The funds have assumed rates between 6.5% and 7%.

Pritzker noted 50% of employees now fall under the Tier 2 pension system, which reduced some benefits for those hired after 2010 and trims future liabilities, but the state potentially faces a future tab to bring the Tier 2 system of benefits up to a level that meets federal rules under which benefits must at least meet what Social Security offers. The state caps annual increases at 3% or half of inflationary growth, which falls short of what Social Security system provides.

When Pritzker took office, the state’s forecast warned of a structural budget gap of $1.8 billion that was expected to grow to $3.2 billion by fiscal 2025. The forecast now anticipates a positive balance of $357 million in fiscal 2024 and gaps have been trimmed to $384 million in fiscal 2025, $625 million in 2026, $567 million in 2027, and $708 million in 2028.

Pritzker did stress the state is accounting for an expected fall-off in revenues through conservative forecasting. “We again have work to do” but “we are a hair’s breadth away from eliminating that structural deficit going forward and I’m focused on that,” Pritzker said.

The administration doesn’t count the difference between its statutory pension contribution and an actuarially determined contribution — which is $4.4 billion more than the $10.9 billion statutory pension contribution in the next budget — in its structural assessment, as some rating agencies do.

Cash balances in various special accounts, some of which are restricted, hold $22.3 billion, more than double the $10 billion they held in 2019.

Investor worries remain high over the long-term weight of the pension burden and how the state would manage economic downturns.

“For three or four years it might be smooth sailing,” said one investor who attended the conference. “If Pritzker is there, he’s uniquely positioned to toe the line, but they are going to have to face the music in the future when revenues are down” and future leaders might lack discipline to keep spending in check.

Pritzker and the finance team fielded questions about whether the state can sustain its progress amid a recession as federal COVID relief is exhausted, what actions he could take to cement fiscal policies that have helped the state’s trajectory, and the significance of last week’s announcement that Chicago was chosen to host the 2024 Democratic National Convention.

“We never assumed this was something that would last forever,” Pritzker said of the federal relief, which included $8 billion of ARPA funds. “One thing I’ve made clear … these ARPA dollars coming to the state we have to spend on one-time things.”

“I’m always looking again for new ways to attack this in a way that doesn’t diminish the pensions that are owed to people who currently work for state government,” but does reduce the unfunded liabilities, Pritzker said. He did not offer any plans under consideration to cement actions like supplemental contributions.  

On the convention, Pritzker said: “One thing it does is bring in 50,000 people over a very short period of time. It has the potential for $150 million to $200 million of economic activity just during those four days of the convention” and it “brings very positive press” that highlights the “great things about Chicago.”

The deal
“We are looking to go to market on Wednesday if the market cooperates,” said Paul Chatalas, the state capital markets director.  

The deal is being offered in four series including a $200 million taxable tranche that will go toward the state’s ongoing pension buyout programs that run through 2026, $1 billion of tax-exempt new money for capital projects, $150 million of new money tax-exempts for IT projects, and $1.1 billion of GOs in a series to refund outstanding debt for savings, market permitting, Chatalas said.

Wells Fargo Securities, Goldman Sachs, and Loop Capital Markets LLC will be joint senior managers.

State GO spreads have narrowed over the course of the year due to a confluence of its ratings upswing and improving market conditions, with turmoil and mutual fund outflows easing and scant supply. The influx of Illinois paper flooding the primary will offer a reset for the state’s bond values, said market participants.

The deal faces competition with a slate of $11 billion in supply this week that marks the largest weekly total so far this year. “At adjusted levels there will be demand,” but pricing concessions might be demanded due to the size and market technicals, said one investor. “Given the heavy calendar and banks potentially selling off of bonds, buyers are being more selective.”

The state’s one-, 10-, and 25-year maturities are currently trading at 55/125/145 basis points, respectively, to the Municipal Market Data’s AAA benchmark. That shows a 20 bp narrowing from the 75/145/165 bp spreads of one month ago.

Spreads in mid-February began trending down — at 110/163/175 bps — after rising to 120/173/185 in mid-January. In mid-December spreads were at 100/163/175.

The secondary market is trading Illinois 10-year paper at an 89 bp spread to the single A benchmark and 35 bps to the BBB benchmark.

The state’s October issue saw the 10-year in the deal land at a 152 bp spread. It’s currently set at a 131 bp spread while the 25-year landed at a 168 bp spread and is now trading at 133 bps, according to Refinitiv-MMD.

Facing market tailwinds, the state’s May 2022 issue saw its 10-year maturity widening to a 138 basis-point spread from a recent low of a 54 basis-point spread in December 2021.

“With the muni market poised to benefit from the seasonal tailwinds, we expect the spreads for Illinois have room to continue to tighten further,” CreditSights said in its weekly Muni New Issue Notes, citing looming municipal redemptions in the coming months that includes $24.3 billion in May.

CreditSights noted the state’s improving spread picture based on Bloomberg’s BVAL which has the 10-year at a 97 bp spread compared to a high in early January of 182 bps, with its average for 2021 at 88 bps and for 2022 at 128 bps. Year-to-date it’s averaged 134 bps.

The movement underscores how the state’s paper that remains the lowest rated among states is “subject to exaggerated fluctuations, especially when there is negative news,” according to the report authored by Patrick Luby, senior municipal strategist, and Sam Berzok, analyst for municipals.

Budget
The deal comes as work on a budget is in its final month, with the General Assembly expected to adjourn by May 19th.

Pritzker’s proposed $49.9 billion general funds budget spends $49.6 billion of revenues, leaving a $300 million balance.

A recent hike in revenue estimates heading into the new fiscal year could pave the way for additional deposits into the rainy-day and pension stabilization funds beyond what’s proposed in Pritzker’s fiscal 2024 budget. Pritzker also has left the door open to tax relief.

The state expects another $575 million of general fund revenues in the current fiscal year as steady income and sales tax collections through February pushed worries over an economic slowdown and the impact of a potential recession further out on the horizon, according to the legislature’s Commission on Government Forecasting and Accountability.

Recession fears loom large over the state and investor perceptions and a recent three-year forecast from COGFA provides fodder for those concerns. “The state faces potentially slowing economic growth in FY 2024 as the country continues to deal with high inflation and elevated risk of a recession,” the report warns.

Under a scenario where spending grows by 1.83% annually — which is below the current average — and the accounts payable are held level to fiscal 2022, year-end deficits of $495 million in fiscal 2024, $882 million in fiscal 2025 and $536 million in fiscal 2026 occur.

Under a scenario that assumes state spending growth of 7.1%, based on the average over recent years, Illinois would see a projected $3.1 billion gap in fiscal 2024 that grows to nearly $6.4 billion in fiscal 2025, and $9.2 billion in fiscal 2026, driving up the accounts payable to $18 billion.

“This example shows that spending patterns seen in the past few years cannot continue without a comparable increase in revenues, which is not seen in the commission’s current estimate,” the report reads.