lundi 5 février 2018

Illinois Unveils Another Shocker: Sell A Record $107 Billion In Debt To Fund Insolvent Pensions

If there is such a thing as financial hell, it is probably Greece... with Illinois coming in close second.

For those unfamiliar, here's a quick recap: Illinois (rate just one notch above junk) is drowning under a mountain of debt, unpaid bills and underfunded pension liabilities and it's largest city, Chicago, is suffering from a staggering outbreak of violent crime not seen since gang wars engulfed major cities from LA to New York in the mid-90's, while rising taxes have prompted a mass exodus with the state lost 1 resident every 4.3 minutes in 2017.

Here is just a small taste of some of our recent posts on Illinois' challenges:

Seen in this light, any irrational actions undertaken by the near-insolvent state would almost make sense, if not be expected. Actually make that irrational and utterly bizarre, such as a proposed offering of a mind-blowing $107 billion in debt - a never before attempted amount in the world of munis - to "fund" the state's insolvent pension system, which would also assure that Illinois would default (even faster) in the very near future.

According to Bloomberg, Illinois lawmakers are so desperate to shore up the state’s massively underfunded retirement system that "they’re willing to entertain an eye-popping wager: Borrowing $107 billion and letting it ride in the financial markets."

If that number sounds oddly large, is because it is: an offering of this size would be by far the biggest debt sale in the history of the municipal market, and amount to roughly 50% more debt than bankrupt Puerto Rico accumulated in the run up to its record-setting insolvency.

Putting the proposed deal in context, Illinois had $26.3 billion of general-obligation bonds as of July and the state sold $750 million of bonds in November to pay down unpaid bills that had accumulated during its two-year budget impasse. The state still has $8 billion of unpaid bills even after that issuance, according to the comptroller’s office.

An Illinois Democrat came up with the perfect soundbite framing this head-scratching proposal:

“We’re in a situation in Illinois where our pension debt is just crushing,” Martwick, a Democrat who chairs the committee, said in a telephone interview. “When you have the largest pension debt in the world, you probably ought to be thinking big.”

In other words, with left nothing to lose, Illinois may as well go big. So big, in fact, it's never been seen before.

What is just as shocking is that not even $107 billion would be enough to fully fund the Illinois pension system, which owes $129 billion after years of failing to make adequate annual contributions.

And since the state’s constitution bans any reduction in worker retirement benefits, the government’s pension costs will continue to rise as it faces pressure to pay down that debt, a squeeze that pushed Illinois’s bond rating to the precipice of junk over the summer when the state avoided a historic downgrade below investment grade with a last minute budget deal.

To be sure, Illinois wouldn't be the first state to issue debt to shore up its pension system: the state did so again back in 2003, when it issued a record $10 billion of them. New Jersey also tried it with catastrophic consequences, seeing its pension shortfall soar again after the state failed to make adequate payments into the system for years. And then there is Detroit’s now infamous pension-fund borrowing in 2005 and 2006 helped push it into bankruptcy.

Will Illinois gamble with a bond offering that - in one deal - could reprice the entire muni bond market? According to Bloomberg, the state legislature’s personnel and pensions committee plans to meet on January 30 to hear more about a proposal advanced by the State Universities Annuitants Association.

The group wants Illinois to issue the bonds this year to get its retirement system nearly fully funded, on one condition: Illinois will pursue the deal assuming that the state can make more on its investments than it will pay in interest.

Ah yes, ye olde IRR: will it be positive or negative?

Naturally, the association which is advocating the plan says it will save the state $103 billion by 2045. That’s because Illinois’s current debt to its pensions grows at the rate that the retirement system expects to earn on its investments, which may be - shall we say - aggressive, and is much higher than the interest rates governments pay to issue municipal bonds.

There is just one problem: whereas Illinois universities expect total returns to keep rising well in the double-digit category, others, such as GMO, forecast real stock returns of -4.7% annually for the next 7 years, while bonds lose 1% in real terms as Mish notes. Offsetting this is the cost of debt, which for the near-junk bonds will likely come out around 6-7% - unless of course the ECB decides to backstop these too - and Illinois Pensions are looking at annual losses of 8%+ every year for the next 7 years.

On the surface, the plan appears to be sheer mathematical idiocy, guaranteeing that Illinois pensions are depleted even faster, but that never stopped Illinois before.

According to the abovementioned democrat Robert Martwick, “if it makes sense, we’ll do it, and if it doesn’t we won’t." Of course, he also said that Illinois has to be "thinking big" and there literally hasn't been a bigger municipal bond sale ever.

As for the rating agencies, they will be thinking just how deep into junk territory to downgrade Illinois. Indeed, as Bloomberg notes, municipal-bond investors would likely frown upon such a massive sale, to say the least.

“Those types of deals are not typically positively received by the rating agencies or investors,” said Eric Friedland, director of municipal research in Jersey City, New Jersey, for Lord Abbett, which holds about $20 billion of municipal debt, including Illinois’s. “That type of issuance could definitely be a credit negative.”

Needless to say, this kind of issuance contemplated by the association would significantly increase the state’s debt burden, and "will not go over well in the bond market,’" said Richard Ciccarone, Chicago-based president of Merritt Research Services LLC, which analysts municipal finance.

"It absolutely increases default risk. There’s no cushion" Ciccarone said.

But that's not Illinois problem: at this point the state's default is only a matter of time, and as such it may as well accelerate it if it means a faster transfer of cash from willing ~~idiots~~ debt investors to the state's retirees. And considering that Illinois' general obligations were trading back at par just a few months ago after tumbling in late 2016...