* Background is here and here if you need it. Reuters…
Yields on Illinois bonds spiked higher on Tuesday in the U.S. municipal market after a constitutional challenge to $16 billion of the state’s general obligation bonds was launched on Monday.
Illinois already pays the biggest yield penalty among states in the $3.8 trillion market due to its low credit ratings, which are a notch or two above junk.
Greg Saulnier, an analyst at Municipal Market Data (MMD), said the spread for Illinois GO bonds over MMD’s benchmark triple-A yield scale had tightened over the past two months as investors gobbled up higher-yielding debt, leaving the state’s bond prices at a greater risk of falling.
“The lawsuit headline was like adding a spark to a powder keg so to speak and trading swiftly indicated spreads wider by 20-25 basis points,” he added.
* Interesting point from Bloomberg…
Pritzker and Illinois Comptroller Susana Mendoza dismissed the lawsuit as a political tactic by John Tillman, the chief executive officer of the Illinois Policy Institute, a conservative think tank, that will be tossed out of court. The case, also filed by New York hedge fund Warlander Asset Management claims the state’s record pension bond sale in 2003 and debt issued in 2017 to pay a backlog of unpaid bills were deficit financings prohibited by the constitution.
Warlander owns $25 million Illinois general-obligation bonds issued in 2001, 2014, 2017 and 2018. Those bonds would be more secure if the firm succeeded in having the other securities invalidated, since there would be more money available to service the debt.
Analysts are skeptical. Citigroup Inc.’s Vikram Rai and Jack Muller published a note on the case after the bank was inundated with calls. They said the lawsuit is unjustified because the Illinois Constitution allows debt to be incurred as long as the law details the specific purpose of the debt and how it will be repaid. Even if it did succeed, they said, the government would likely find a way to repay the debt to avoid being penalized in the bond market. […]
Jason Appleson, a portfolio manager at PT Asset Management LLC, said he believed market consensus is that the lawsuit was frivolous. […]
Appleson attributed the initial widening to “a couple of scared buyers” affecting a light trading day in a slow market. “If this moves forward in court, I think we could see some more widening but if it’s shut down we could see a snap-back in spreads given the market conditions.”