Overview
Illinois will return to the market with $573 million of new money and refunding bonds under a higher-rated sales tax-backed credit.
Details of the Sale
Fitch Ratings said the state will take competitive bids on:
- August 24
- $150 million junior obligation tax-exempt series
- $60 million junior taxable series
- August 25
- $164.3 million junior tax-exempt refunding series
- $198.6 million junior tax-exempt refunding series
These bonds will:
- Finance various capital projects
- Refund certain of the state’s outstanding Build Illinois Bonds for savings
- Pay costs of issuance
A state spokeswoman confirmed these details.
Background
The sale is the first under the state’s Build Illinois credit since 2014.
Ahead of the issue, Fitch affirmed its AA-plus rating and stable outlook for bonds issued under the Build Illinois program. The program currently has:
- $1.86 billion of senior lien program debt
- $654.4 million of junior lien paper outstanding
This rating contrasts sharply with the state’s general obligation (GO) rating, impacted by:
- A $5 billion to $6 billion budget deficit
- A mounting bill backlog
- $112 billion of unfunded pension liabilities
Fitch rates Illinois GOs at BBB-plus and in June placed the rating on Rating Watch Negative due to prolonged partisan gridlock and the absence of a long-term budget solution.
Credit Structure and Strength
Build Illinois bonds benefit from:
- First claim on the state’s 6.25% sales tax
- $8.6 billion generated last year providing debt service coverage levels of 10 times on the junior lien
- Stringent issuance limits:
- No more than 5% of the prior year’s sales tax receipts on the senior lien
- No more than 9.8% on the junior
“Build Illinois bonds have a statutory first lien on the state’s share of the sales tax, strong non-impairment language, and no requirement for annual appropriation,” Fitch wrote.
“In Fitch’s opinion, these provisions insulate the bonds from state operations and support a rating level that is higher than that of the state’s Issuer default rating.”
Ratings from Other Agencies
S&P Global Ratings affirmed the Build Illinois bonds at AAA with a negative outlook in June.
“Increased liquidity pressures on Illinois could test the ability of these revenues to remain isolated from the state and its fiscal pressures,” said analyst John Sugden.
Moody’s Investors Service does not differentiate between the sales tax-backed bonds and Illinois GOs, assigning both its Baa2 rating with a negative outlook.
Considerations on Credit Risk
While contract clause protections under federal and state constitutions restrict impairment of the bondholder pledge, these are not absolute during a fiscal emergency.
“Therefore, the amount of credit Fitch will give to such a structure is tempered by the risk that a state, faced with extreme financial stress, could exercise its sovereign powers to the detriment of bondholders,” Fitch added.
Sales Tax Trends
- 12% decline during the most recent recession
- Recovery growth: 4.1% in 2014 and 4.5% in 2015
- Current growth slowing, partly due to lower gasoline prices
Previous Performance
In the March 2014 Build Illinois deal:
- 7 bids on a $402 million taxable issue
- JPMorgan won with a true interest bid of 4.2706%
Though Illinois bonds carry a penalty for the state’s name, the higher ratings shielded them from steeper spreads compared to stressed GO paper.
- Spreads ranged from 25 to 105 basis points to comparable Treasuries
- Below the spreads of well over 100 basis points on GOs to comparably rated GOs
In its most recent GO sale in June:
- True interest cost: 3.7425%
- Spreads: ~185 basis points to Municipal Market Data’s top-rated benchmark on 10-year maturity
- 172 basis points on its 25-year maturity
Frequently Asked Questions
What is the purpose of Illinois’ $573 million bond sale?
The bond sale will finance capital projects, refund existing Build Illinois Bonds to achieve cost savings, and cover issuance expenses. It also reflects the state’s strategy to leverage higher-rated sales tax-backed credit instead of relying solely on general obligation bonds.
How are Build Illinois bonds structured differently from general obligation (GO) bonds?
Build Illinois bonds are backed by a first claim on Illinois’ 6.25% sales tax, with legal safeguards like non-impairment clauses and no requirement for annual appropriation. These features insulate them from broader state fiscal issues and allow them to earn higher ratings than GO bonds.
Why are Build Illinois bonds rated higher than Illinois’ GO bonds?
Despite the state’s financial challenges including a large deficit and pension liabilities, Build Illinois bonds are rated higher due to their strong legal structure, dedicated sales tax revenue, and limited issuance caps. Fitch affirmed an AA+ rating while S&P maintained a AAA rating for these bonds.
When was the last Build Illinois bond sale prior to this?
The last Build Illinois bond sale occurred in March 2014, featuring strong investor interest and favorable spreads compared to the state’s GO bonds, despite the state’s name carrying some yield penalty in the market.
What risks still apply to Build Illinois bonds despite their higher ratings?
Although these bonds are structurally insulated, Fitch notes that in a severe fiscal crisis, Illinois could still use its sovereign powers in ways that might affect bondholders. Legal protections aren’t absolute in fiscal emergencies, which tempers credit assessments.