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Illinois Pays Pension Bond Premium as Budget Fix Eludes State

January 8

Jan. 8 (Bloomberg) -- Illinois, the second-lowest rated U.S. state, paid more than some comparably ranked U.S. companies when it sold $3.47 billion of taxable bonds to finance its annual contribution to a public employee pension fund.

The state, downgraded last month by Standard & Poor’s and Moody’s Investors Service, paid as much as 4.421 percent yesterday on the bonds, which mature in one to five years. The top rate was 182 basis points, or 1.82 percentage points, higher than the yield on five-year U.S. Treasuries, according to data compiled by Bloomberg. Corporate securities rated A that mature in three to five years traded 154 basis points over Treasuries yesterday, indexes from Bank of America Corp.’s Merrill Lynch & Co. show.

“They certainly did have to pay a premium to get this deal done,” said Matt Buscone, a portfolio manager at Boston’s Breckinridge Capital Advisors Inc., a money manager overseeing $11 billion in assets, which bought Illinois debt maturing in two years. Municipal bonds “are subject to a lot of bad headline risk these days” with deteriorating state and local budgets, he said. “Headline risk” refers to the potential effect of bad news on investment values.

Governor Pat Quinn is using borrowed money to make the pension fund contribution, to avoid using cash as he attempts to close a budget gap that the Center on Budget and Policy Priorities estimates at $5 billion at the middle of the fiscal year.

‘Downward Slide’

Illinois’ finances are in a “downward slide” with $5.1 billion in unpaid bills to end last year, part of an “ongoing fiscal disaster,” state Comptroller Daniel Hynes said in a report the day before the offering. Hynes is challenging Quinn, who replaced Governor Rod Blagojevich last year, in the Democratic primary election on Feb. 2.

John Sinsheimer, hired in October as the state’s director of capital markets, said the interest rate reflected Illinois’ downgrades. Illinois received more than $8 billion in orders from 200 investors in the U.S., Asia and Europe for the $3.47 billion in securities, he said.

“The market is efficient and we paid the right price,” Sinsheimer said in a telephone interview. “The state is very pleased with the results.”

Illinois’ credit is rated A2 by Moody’s, its sixth-highest grade, and the equivalent A+ by S&P. Fitch Ratings ranks the state A and said last month that it may also reduce the rating. Only California is lower, at Baa1 from Moody’s and A from S&P.

The Illinois offering is taxable since federal rules preclude proceeds of tax-exempt borrowings from going into funds that invest in potentially higher-yielding investments such as stocks.

May Have Overpaid

Scott Minerd, who helps supervise more than $100 billion as chief investment officer of Santa Monica, California-based Guggenheim Partners LLC, said it looked like Illinois overpaid relative to corporate debt.

“It sounds like they had to pay up,” said Minerd, who didn’t participate in the offering, citing the size of the deal and the “saturation” of the market. “I’d have thought they could have gotten a better price.”

Illinois paid more than recent sales by Dr Pepper Snapple Group, the soft drink maker, whose debt is rated only one level above junk bond status. Dr Pepper sold two-year bonds on Dec. 14 at 90 basis points more than Treasuries. Those bonds changed hands on Jan. 6 at 56 basis points more than Treasuries in a $3 million trade and 53 basis points in two trades totaling $7 million, according to Bloomberg data.

Corporate Debt

Dr Pepper Snapple sold a three-year issue at 103 basis points above Treasuries on Dec. 14, which traded yesterday in three transactions of more than $15 million at 55 basis points above the benchmark. Sherwin-Williams Co., the largest U.S. paint retailer, rated one level lower than Illinois, at A3 by Moody’s and A- by Standard & Poor’s, sold $500 million of two- year bonds last month at 82 basis points more than Treasuries.

Illinois paid 2.77 percent on pension bonds maturing on Jan. 1, 2012, and 3.32 percent on bonds maturing on Jan. 1, 2013, both 175 basis points above Treasuries, according to Bloomberg data. New York-based JPMorgan Chase & Co. led a team of more than 10 banks selling the bonds. Justin Perras, a spokesman for JPMorgan, declined to comment on the pricing. Chicago-based Peralta Garcia Solutions LLC was the state’s financial adviser.

Rise in Trading

The state’s bonds rose today in secondary market trading, with more than 15 trades of more than $1 million of the securities due in 2015, according to data from the Municipal Securities Rulemaking Board. The 4.42 percent bonds traded as high as 101.36 to yield 4.11 percent, according to the market regulator. Treasury notes due in five years rose about 1/8 point, or $12.50 per $1,000 bond, today.

The weekly Bond Buyer index of 20-year, tax-exempt bonds rose to 4.31 percent yesterday, up from 4.25 percent the week prior. The index reached its lowest since at least 1980 on Oct. 1, at 3.94 percent.

In another offering, the New Jersey Transportation Trust Fund Authority sold $859 billion in Capital Appreciation Bonds and taxable Build America Bonds yesterday and Jan. 6.

The $359 million in Capital Appreciation Bonds maturing between 2025 and 2040 sold with yields of 5.85 percent to 6.25 percent, said Tom Vincz, a New Jersey treasury spokesman. The issue pays interest only at maturity, he said. The Build America Bonds that mature in 2040 were priced to yield 6.561 percent before a 35 percent federal rebate, Vincz said.

To contact the reporters on this story: Michael McDonald in Boston at [email protected]; Michael Quint in Albany, New York, at [email protected].