CHICAGO, June 27 (Reuters) - While a legislative committee reopened a debate on how to fix Illinois pensions, a panel of municipal analysts said on Thursday that the state paid "dearly" for its bond sale this week. Rising interest rates will only increase the state's borrowing costs, the analysts added.
Investors demanded hefty yields to take on Illinois' $1.3 billion in tax-exempt general obligation bonds on Wednesday as the state struggles with a huge unfunded public pension liability that has eroded its credit ratings.
Interest rates in the deal topped out at 5.65 percent for bonds due in 25 years, compared with 3.83 percent for top-rated muni issuers. That resulted in a 182-basis-point spread over Municipal Market Data's benchmark yield scale for triple-A-rated bonds, up from the spread of 138 basis points that Illinois bonds were fetching in the secondary market over Tuesday's scale.
The state "went into an adverse market and this time, it did cost them dearly," said Richard Ciccarone, a managing director at McDonnell Investment Management, speaking during a panel discussion sponsored by the Illinois Chamber of Commerce and Reboot Illinois, a nonpartisan organization that works to get the state's residents involved in its political process.
Ahead of the deal, yields in the $3.7 trillion market had risen to levels not seen since 2011. The market, however, reversed direction on Wednesday, easing yield levels a bit.
Illinois, which acknowledged the bond pricing cost the state an extra $130 million over the life of the issue, forged ahead with the deal because the bond proceeds were needed to fund critical infrastructure projects that could not be stopped.
The taxable equivalent on the deal's 25-year yield was just over 9 percent - a rate available only from the worst credits in the corporate bond market, Ciccarone said.
Illinois' GO bond rating has slid down the credit scale to the A-minus/A3 level with negative outlooks - the lowest among U.S. states - as pension payments weigh down its finances.
Illinois' rating would have to fall four more notches to reach the junk category.
If that happens, some investors would be forced to sell the state's bonds, said Cadmus Hicks, a managing director at Nuveen Asset Management. He pointed out that under that scenario, the state's spread over MMD's scale could rise to 300 basis points - a level paid only by Puerto Rico among large muni borrowers.
HEDGE FUNDS' INTEREST?
Ciccarone said interest rates, which have been rising on the fear that the U.S. Federal Reserve will gradually scale back its expansionary monetary policy, will make it increasingly more difficult for Illinois to sell debt at reasonable rates. And even though Wednesday's issue was oversubscribed with more than $9 billion in orders, it likely attracted hedge fund buyers, who could create more volatility for the state's debt - unlike traditional buyers like mutual funds and individuals, he added.
Hicks said the state, which in the past turned to pension bonds, skipped or skimped on its annual pension payments, should take the first step of making actuarially required payments every year.
Moody's Investors Service said on Thursday that Illinois' pension burden is the largest among states. Its net pension liability - the difference between projected benefit payments and assets set aside to cover them - equals 241 percent of the state's revenue.
Governor Pat Quinn, who signed education funding bills for the fiscal 2014 budget on Thursday, said pension payments were hindering the amount of money the state could spend on schools.
"Lack of action on pension reform is squeezing out money that should be invested in our critical priorities like early childhood development, special education and scholarships for students in need," he said in a statement.
An Illinois legislative conference committee, charged with coming up with a pension solution for state lawmakers to vote on by July 9, held its first meeting on Thursday. At a standing-room-only hearing in Chicago, the 10-member bipartisan committee heard from business groups, unions, state officials and others about ways to tackle a nearly $100 billion unfunded pension liability.
State Senator Kwame Raoul, a Democrat and the chairman of the conference committee, said discussion will not be limited to dueling pension-reform bills championed by the Democratic House speaker and Senate president.
"There's a universe of options out there, and I think we do ourselves a disservice not to consider them," Raoul told reporters ahead of the hearing.
The committee will meet again on July 3, but it was unclear if a pension proposal would be in place by the July 9 deadline.