Bloomberg News

Illinois Beloved as Worst Pension Fails to Scourge: Muni Credit

August 16, 2012

Illinois has set aside only 45 percent of what it needs to meet public-worker pension obligations, the worst of any U.S. state. Standard & Poor’s may cut its bond rating if lawmakers don’t come up with a fix tomorrow. Investors are unfazed.

The fifth-most populous state’s unfunded pension liability is growing by an estimated $12.6 million a day, according to Democratic Governor Pat Quinn’s budget office. Yet the penalty on general-obligation bonds from issuers in Illinois, relative to top-grade debt, fell to 1.51 percentage point last month, the lowest since February 2011, data compiled by Bloomberg show.

At the same time, neighboring Wisconsin, with a 99.8 percent pension-funding ratio, has seen spreads on similar debt more than double over the same period.

“Investors are believing the situation is on the way to being resolved, but not everyone’s believing that,” Richard Ciccarone, director of fixed-income research in Chicago for McDonnell Investment Management LLC, said of Illinois.

“I want to see the whites of their eyes,” Ciccarone, whose firm owns more than $8 billion in munis, said in a telephone interview.

Illinois is battling the same force that has helped throw cities from Stockton, California, to Central Falls, Rhode Island, into bankruptcy: unsustainable retirement expenses. Quinn, 63, called on the Democratic-controlled Legislature to enact cost-cutting changes “without delay” when he announced tomorrow’s special session on July 30.

Rating Imperiled

State contributions to the $63 billion consolidated retirement system in fiscal 2013 are projected to reach $5.2 billion, up from $4.1 billion in the fiscal year that ended June 30, budget documents show. Standard & Poor’s said in April it may cut Illinois’s rating from A+, the fifth-highest, if lawmakers don’t enact “structural budget solutions” and address “significant pension liabilities.”

California, at A-, is the only state graded lower by the New York-based company. Moody’s Investors Service downgraded Illinois in January to A2, its lowest grade for a state.

A threatened downgrade may not be enough to prompt action from lawmakers, who’ve been unable to agree on revamping the state’s five pension plans for teachers, judges, legislators, university employees and state workers.

“We’re not anticipating resolution of a pension-reform plan on Aug. 17,” said John Miller, co-head of fixed-income investment in Chicago at Nuveen Asset Management, which oversees about $86.5 billion in munis, including Illinois general- obligations. “I wouldn’t be shocked to see a downgrade between now and year-end.”

Higher Contributions

The unfunded pension liability is at least $83 billion, according to state figures. Lawmakers have proposed increasing employee contributions and passing some state costs onto local school districts.

The most meager yields in a generation have pushed investors into lower-quality debt issued in states such as Illinois, Ciccarone said.

The yield on top-grade munis maturing in 10 years declined to 1.63 percent on July 27, the lowest since January 2009, according to a Bloomberg Valuation index. That decline accompanied a wave of about $142 billion flowing to bondholders from redemptions and refinancing that started in May, the most ever for a three-month period, according to Citigroup Inc.

“If we were in a more normal environment, we’d see a wider spread for the state of Illinois based on credit quality,” Ciccarone said. “To make conservative investors comfortable, they have a long way to go.”

Wisconsin Penalty

Issuers in Wisconsin, which has the third-highest grade from both S&P and Moody’s, have seen spreads on their debt widen. The difference between general-obligation bonds sold by the state and its localities widened to 0.45 percentage point this month relative to top-rated muni debt, the most in about a year, Bloomberg data show. It’s more than triple the 0.13 percentage point penalty investors demanded for the securities in February 2011, the data show. The Illinois penalty has declined by about 0.33 percentage point since then.

Although Illinois lawmakers raised personal and corporate income taxes in 2011, the state carries a backlog of about $8 billion in unpaid bills.

“I expect this process to be politically noisy and messy,” Molly Shellhorn, senior research analyst at Nuveen, said of tomorrow’s legislative meeting.

“We will look for pension reform to hopefully be passed this session,” she said. “But if it’s not all completed on Friday, we’re not going to be panicked.”

TEXAS is set to borrow $9.8 billion of revenue-anticipation notes as soon as Aug. 21 through competitive bid, Bloomberg data show. Moody’s rates the sale MIG 1, its highest short-term rating. (Added Aug. 15)

DALLAS plans to sell $366.9 million of wastewater and sewer-system revenue debt, including taxable bonds, as soon as next week, Bloomberg data show. Proceeds will refinance debt. Moody’s rates the bonds Aa1, its second-highest grade. (Added Aug. 15)

Editors: William Glasgall, Mark Schoifet

To contact the reporters on this story: Brian Chappatta in New York at bchappatta1@bloomberg.net Tim Jones in Chicago at tjones58@bloomberg.net

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net


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