Illinois to sell $1 bln bonds, but investor concerns linger

CHICAGO Wed Feb 5, 2014 2:34pm EST

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CHICAGO Feb 5 (Reuters) - A looming revenue decline, heaps of unpaid bills and multiple lawsuits hang over Illinois' planned $1 billion bond sale on Thursday, though the fiscally-challenged state's recent pension reform law may afford it a modest break on borrowing costs.

Though it still pays more than any other state, Illinois saw its 10-year borrowing premium slip to 120 basis points over top-rated municipal bonds in recent weeks, down from more than 170 basis points late last year.

A long-awaited pension reform law enacted in December with an effective date in June may have helped the state, which has the lowest credit rating among all 50 U.S. states.

Even so, there is plenty for investors to worry about. Enactment of the pension reforms, which are projected to save the state nearly $145 billion over 30 years, has sparked four lawsuits by labor unions and others.

Illinois also faces a $1.4 billion drop in revenue in the upcoming fiscal year as some big income tax rate hikes enacted in 2011 are scheduled to partially expire on Jan. 1, according to projections released by Quinn's budget office last month.

In fiscal 2016, the first full year of the rate rollback, income tax collections are forecast to fall by another $2.7 billion. That would help to more than double a projected deficit in the state's $37 billion general funds budget to $4.1 billion from $1.9 billion in fiscal 2015, which begins July 1.

"They still have wood to chop," said Paul Brennan, a senior vice president and portfolio manager at Nuveen Investments. "Pensions are still eating a lot of their general fund revenue and they still have forward-looking deficits they have to close."

Standard & Poor's downgrade of Puerto Rico on Tuesday may also prompt hesitation if buyers are wary of new bonds from higher-risk issuers.

That said, Illinois could benefit from the low level of supply in the $3.7 trillion market so far this year, and its bonds could stand out for investors hunting for yield, said Dan Solender, head of municipal investments at Lord Abbott & Co.

"It's probably a good time to bring a deal," he said.

The general obligation bond issue, the state's first tax-exempt deal since December, is structured with serial maturities from 2015 through 2034 and term bonds due in 2039, according to the preliminary official statement.

John Sinsheimer, the state's capital markets director, said pricing through lead manager Citigroup was still on track.

LONGER-TERM QUESTIONS

But how the state will deal with its projected revenue loss is seen as a key question for the fiscal 2015 budget. Democratic Governor Pat Quinn this week asked the legislature to delay his fiscal 2015 budget address to March 26 from Feb. 19.

The Democrat-controlled legislature could vote to keep tax rates where they are.

However, Michael Madigan, the powerful speaker of the Illinois House of Representatives, last week introduced a bill to permanently and retroactively reduce the corporate tax rate to 3.5 percent - lower than the 4.8 percent rate in place prior to the 2011 tax hike - which would cut revenue by about $1.5 billion annually.

Under current Illinois law, the rate on business profits is scheduled to drop to 5.25 percent from 7 percent on Jan. 1. The personal income tax rate will fall to 3.75 percent from 5 percent.

The state has managed to shrink its pile of unpaid bills, which stood at $4.7 billion on Tuesday, according to the Illinois Comptroller's website, down from $6.1 billion at the end of fiscal 2013.

But implementation risk for the pension reforms along with uncertainty over the future of the tax hikes have led credit ratings agencies to keep negative or developing outlooks on Illinois' A-minus and A3 ratings.

Political wrangling is likely to heat up as well. Quinn is up for re-election this year and four Republicans will face off in a March 18 primary for the right to challenge him in November.

Quinn is facing a relatively weak challenge for the Democratic nod.

Illinois Senate Republican Leader Christine Radogno has said Quinn's delaying the budget until after the primary was done for "purely political purposes," and was not fair to taxpayers.

Brooke Anderson, Quinn's spokeswoman, said Quinn wants more time to review the latest economic and revenue data and to prepare a five-year budget blueprint. She also denied the later date had anything to do with Quinn's bid for re-election.

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