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Swap risks spur Illinois search for legal expert

Published 04/15/2016, 04:56 PM
Updated 04/15/2016, 05:00 PM
© Reuters.  Swap risks spur Illinois search for legal expert
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By Karen Pierog

CHICAGO (Reuters) - Illinois is seeking legal help as its deteriorating credit standing threatens to end bond-related deals with banks at a big cost to the cash-strapped state, according to a government website.

A week ago, Illinois advertised for an outside law firm to assist with potential termination of interest-rate swap transactions and with replacing bank letters of credit, both related to $600 million of variable-rate bonds issued in 2003.

Illinois set an April 22 deadline for responses from bond counsel firms, in a request for proposals on the state's procurement website.

"The Rauner Administration is exploring options to reduce taxpayers' risk exposure to swap agreements entered into by prior administrations," Catherine Kelly, a spokeswoman for Republican Governor Bruce Rauner, said on Friday in an emailed answer to questions.

The nation's fifth-largest state is inching closer to a situation that could trigger termination of interest-rate hedge agreements with five banks.

Further downgrades of Illinois' relatively low general obligation credit ratings could force the state to pay termination fees to the banks recently estimated at $163 million, according to the state's solicitation to prospective law firms.

The trigger would be a two-notch downgrade of the state's Baa1 rating with Moody's Investors Service to Baa3 or a three-notch downgrade of its A-minus rating with Standard & Poor's to BBB-minus. Both agencies have warned of future downgrades if Illinois' big pension problem and structural budget deficit worsen.

Illinois has the lowest credit ratings and worst-funded public pensions among the 50 U.S. states. An impasse between its Republican governor and Democrats who control the legislature has left the state without a full budget for the fiscal year that began July 1.

The state's pile of unpaid bills, a gauge of its structural deficit, has ballooned to $7.36 billion, while options for dealing with a $111 billion unfunded pension liability are limited.

The swap counterparties are AIG Financial Products Corp, Bank of America (NYSE:BAC), Merrill Lynch Capital Markets, JP Morgan Chase (NYSE:JPM), and Loop Capital Markets with credit support from Deutsche Bank AG (DE:DBKGn).

Also looming is the Nov. 26, 2016 expiration of six bank direct-pay letters of credit backing the variable-rate bonds. If the facilities are not renewed by the current banks or replaced by other banks, the state could be forced to pay off some or all of the bonds before their 2033 maturity. The letters of credit are from JP Morgan Chase Bank, PNC Bank, Wells Fargo (NYSE:WFC) Bank, State Street Bank and Trust Company, Royal Bank of Canada, and The Northern Trust (NASDAQ:NTRS) Company.

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