State sells $900 million in bonds

Third of higher interest rate to be offset by federal govt.; cash to fund public works projects

Thursday, July 15, 2010

The state of Illinois, its debts escalating with its backlog of unpaid bills, Wednesday sold $900 million in Build America Bonds to support public works projects, but paid a higher interest rate for the privilege.

Nevertheless, state officials could claim taxpayers were getting a good deal because 35 percent of the bonds' interest is paid by the federal government. They also said there were plenty of bidders for the debt, even though Illinois and California have the poorest ratings for creditworthiness of any state.

John Sinsheimer, the state's director of capital markets, said the bonds pay an average interest rate of 6.96 percent. After the federal government's subsidy, the cost to the state will be 4.56 percent for the 25-year bonds, he said.

He reported that the bonds drew extensive bidding despite downgrades to Illinois' credit rating and its inability to close a $13 billion budget deficit. Sinsheimer said more than $2 billion in orders were received for the bonds. Of the more than 90 institutional investors bidding for the bonds, 17 were from overseas, Sinsheimer said.

"If the yields are high enough, you'll bring out people willing to take on additional risk," said Marshall Front, chairman of investment advisory firm Front Barnett Associates LLC in Chicago. He said that once the bonds hit the resale market, the prices slipped, driving the yield to 7.35 percent. With bonds, the lower the price, the higher the yield, even though the interest the initial issuer pays is unchanged.

"Illinois and California are trading very weakly," Front said. "They are really trading like junk bonds."

But there's security in that "junk." Analysts said Illinois bonds remain attractive because of the state's large economy and broad power to tax. Also, state law gives bondholders priority for payments over others to whom Illinois owes money.

Christopher Mier, municipal strategist for Loop Capital Markets, said no state has defaulted since Arkansas during the Great Depression. His Chicago firm manages bond issues for Illinois, but was not involved in Wednesday's business.

Mier said all states' need for debt "requires that they maintain themselves as 'buyers in good standing' in the municipal bond market. The likelihood that any state, including Illinois, would miss a payment on a bond issue is extremely low."

Sinsheimer estimated that the state paid an interest rate premium of 25 basis points, or 0.25 percentage points, because of its lower credit rating.

The difference would translate into additional interest payments of about $2.25 million a year.

Comparisons in the bond market are difficult because debt from state and local governments have various maturity dates and credit ratings. Other analysts believe Illinois pays a somewhat higher penalty for its fiscal mess.

Regardless, some investors still aren't interested in the bonds. Edward Gjertsen II, vice president at Mack Investment Securities Inc. in Glenview, said he has steered clients away from debt issued by state and local governments for around a year. "I see more deterioration in their ability to work out their budgets," he said.

Gov. Quinn's budget office said the proceeds from the Build America Bonds should create about 14,000 jobs. Repairs to roads, bridges and schools are among the projects expected to be funded. Build America Bonds are taxable, unlike municipal bonds, and were created to ease governments' credit access when investors were feeling the municipal market.

More Illinois debt issuances are ahead. Sinsheimer said the state expects to sell $1.3 billion in short-term debt next week to whittle at a pile of unpaid bills. The state comptroller's office said those bills exceeded $5 billion as of the end of last year.

In November, the state also plans to sell $1.4 billion in bonds backed by receipts from a legal settlement with tobacco companies.