Illinois’ Bond Sale: Was the Cost Historically Low or Too High?

On January 11, 2012, the State of Illinois sold $800 million of General Obligation bonds to support capital projects. The bond offering included $525 million of tax-exempt bonds, as well as $275 million of taxable bonds to reimburse other governments for previously completed projects. 

The sale attracted considerable attention because it came just days after a rating agency reduced the State’s credit rating to the lowest among U.S. states. Observers were interested in whether the negative verdict on Illinois’ finances would increase the State’s borrowing cost.

After the bonds were sold, Governor Pat Quinn’s Office of Management and Budget (GOMB) announced that the State had been able to sell the tax-exempt portion of the bonds at 3.9125%, the lowest rate in recent Illinois history. The taxable bonds were sold at an interest rate of 5.2992%.

Other reports, however, stated that Illinois’ tax-exempt interest cost was still high compared to municipal governments with the highest credit ratings.

Even though they seem to be at odds, there is evidence to support both perspectives. While the GOMB statement focused on Illinois’ total cost to sell the bonds, other observers emphasized how much higher the State’s borrowing costs were relative to top-rated issuers.

On January 11, 2012, the day of the Illinois bond sale, the overall municipal bond market was reportedly bolstered by a rally in Treasury bonds. Yields for both Treasury securities and municipal bonds reportedly ended the day at historically low levels. In addition, news reports cited a relatively low supply of new municipal bonds on the market and strong demand by investors due to bond redemptions in January.

GOMB said in its statement that it received eight bids for the tax-exempt portion of the competitive bond sale and nine bids for the taxable portion. The statement asserted that investors realize that the State is taking steps to fix its financial problems.

Moody’s Investors Service took a less optimistic view of the State’s finances on January 6, 2012, when it downgraded Illinois’ debt rating from A1 to A2, the lowest rating among U.S. states. Moody’s pointed to Illinois’ inaction on its severely underfunded pensions and to its chronic backlog of unpaid bills. Moody’s also revised the State’s outlook from negative to stable.

After the January 11 bond sale, some reports said that Illinois’ interest cost had increased relative to AAA-rated debt. For instance, ten-year AAA-rated debt was trading at a yield of 1.79%, compared with the ten-year bonds sold by Illinois that were priced at 3.1%.

Moody’s downgrading of Illinois debt came three days after the Governor’s Office issued a revised budget plan for FY2012 and a three-year budget forecast covering FY2013 to FY2015. As discussed here, the projections showed a $508 million operating deficit in FY2012, despite a significant increase in individual and corporate income tax rates. The projections showed an operating deficit of $818 million in FY2015, when the tax increases are scheduled to partially sunset in the middle of the fiscal year. In addition, the projections did not take into account the full cost of the State’s Medicaid program and did not deal with a multi-billion dollar backlog of unpaid bills.

Two other rating agencies did not change their ratings for Illinois. Standard & Poor’s affirmed an A-plus rating but retained a negative outlook. S&P said it was concerned about the State’s failure to make meaningful changes to align revenues and expenditures and about the weakness of the pension funds. Fitch Ratings affirmed an A rating with a stable outlook but stated that the State needed a long-term solution to the gap between revenues and expenditures.

The following chart compares Illinois’ General Obligation bond ratings in December of 2008 to the current ratings from each agency.

The next chart compares all three major agencies’ current ratings for California and Illinois General Obligation bonds. Illinois is rated lower than California by Moody’s, but the State has a higher rating than California from the other two agencies.

It is important to note that the rating assigned to municipal debt is often the starting point in determining how much an issuer will end up paying to access the credit markets. Market conditions, the size and structure of a government and other competing issuances are other factors considered by bond underwriters and investors.