The state most likely to default? Not California, say swaps

The cost of insuring Illinois's bonds against default rose to the highest level in five months as the state headed for the new year without a plan to finance a $3.7 billion pension-fund contribution. The cost of credit-default swap insurance on the lowest- rated state after California has risen 16 percent to $330,000 to protect $10 million of debt, from $285,000 on Dec. 3, according to data compiled by Bloomberg. That's the most expensive since July 12, when it reached $335,000. “They're punishing all the states but they're punishing the worst states more,” said Alan Schankel, director of fixed- income research for Janney Montgomery Scott LLC, a money- management firm based in Philadelphia. “Illinois has been worse for a while.” Insuring Illinois against default now costs more than that for California, the lowest-rated U.S. state according to Standard & Poor's. Covering the most-populous state's general- obligation debt averaged $291,000 in December, Bloomberg data show. S&P ranks California at A-, its fourth-lowest investment grade, and Illinois at A+, two levels higher. The cost of insuring Illinois debt is more than three times that of Texas at $102,000. Texas, which S&P said felt the effects of the recession later and began to pull out earlier, may face a deficit of as much as $25 billion in the next two years, according to an Oct. 25 report in the Dallas Morning News. State officials have already begun asking for spending cuts in advance of the 2011 legislative session, during which the next two-year budget will be written. Bill Gross, who runs the world's biggest bond fund at Pacific Investment Management Co. in Newport Beach, California, said Illinois's budget may be only 55 percent-funded. “That means the other 45 percent they can't pay or have to borrow,” Gross said today in an interview on CNBC. “How a state like that can get in that type of position, I'm not quite sure.” He said he would avoid buying any Illinois debt. Municipal issuers are selling about $483.4 million in the last week of 2010, Bloomberg data show. Top-rated 10-year municipal bonds were yielding 3.16 percent yesterday, unchanged from last week, according to Municipal Market Advisors data. The budget Illinois lawmakers passed earlier this year has a $13 billion gap, about half of total spending. The state sold securities backed by its share of a settlement with tobacco companies to help pay $2 billion of bills left over from fiscal 2010. Illinois issued $3.47 billion of pension bonds in the first week of 2010 at as much as 4.421 percent on debt that matures in one to five years. The top rate was 182 percentage points higher than the yield on five-year U.S. Treasuries, according to data compiled by Bloomberg. The state was planning a sale of $3.7 billion for its fiscal 2011 pension contribution until lawmakers refused to pass a measure authorizing the debt when they met to wrap up legislative affairs after the November election. The plan still may be considered when lawmakers meet again starting next week. Kelly Kraft, spokeswoman for Illinois governor Pat Quinn's office of management and budget, didn't immediately respond to two e-mails seeking comment. Quinn yesterday proposed borrowing $15 billion to alleviate the pressure of the state's unpaid bills, the Chicago Tribune reported. The governor approached legislators with the plan to plug Illinois's budget hole for a year, the newspaper said. State and local issuers have been seeing costs for their credit-default swaps widen since banking analyst Meredith Whitney on Dec. 19 predicted “hundreds of billions of dollars” of municipal defaults during an episode of CBS Corp.'s “60 Minutes,” Schankel said. Those states in worse financial shape have seen their costs rise more, he said. --Bloomberg News--