Judge hears arguments on Illinois taxpayer lawsuit on GO bonds

BY SourceMedia | MUNICIPAL | 08/15/19 03:34 PM EDT By Yvette Shields

SPRINGFIELD, Ill. — The municipal bond market must wait up to two weeks to learn whether a judge will allow a complaint that seeks to invalidate $14.3 billion of Illinois general obligation bonds to proceed.

The case was “well-briefed” and “well-argued” on both sides, Sangamon County Circuit Court Judge Jack D. Davis II said Thursday. “There’s a lot of a material here” and I “believe it is warranted for some further review.”

He said he would rule within the next 14 days on whether the case should be allowed to proceed as a taxpayer action complaint.

Warlander Asset Management LP and John Tillman, who is head of the Illinois Policy Institute which is a frequent critic of state financial management, filed their petition asking for permission to file a taxpayer action complaint early last month. The complaint names Gov. J.B. Pritzker and other state constitutional officers as defendants and seeks to invalidate outstanding debt from the state's $10 billion 2003 GO pension bond deal and $6 billion of GOs issued in 2017 to pay down the state's bill backlog.

A handful of professionals from institutional investment houses and investment banks attended the hearing in Springfield as the market looks for signals as to whether the courts will conclude that the lawsuit meets the legal criteria to proceed. If so, the case would then be litigated on its merits.

The petitioners are seeking to block any further repayment of the remaining $14.3 billion outstanding on the premise that the state failed to meet the legal threshold for issuing the bonds, including a requirement that the “special purpose” for the bonds be documented. Illinois Attorney General lawyers have countered that the bonds met all legal requirements of the state's borrowing laws and were reviewed by its office and bond and underwriters' counsel.

Thursday's proceedings confirmed that the hedge fund behind the lawsuit would profit from a default.

Nuveen Asset Management LLC and AllianceBernstein LP put forth the claim in a joint brief filed Friday asking the court to allow it to file an amicus brief in support of Illinois’ position that the bonds were legally issued and should continue to be paid.

"On information and belief, Warlander has bought credit default swaps well in excess of its nominal $25 million in GO bonds” from money-center financial institutions and “if swaps are Warlander’s undisclosed ‘separate financial interest in the litigation,’ then Warlander stands to reap an extraordinary profit from the mere pendency of this litigation,” the amicus brief argues. Warlander holds $25 million of bonds not being challenge.

The judge agreed to allow the amicus filing so it becomes part of the case record he will consider in making his decision. Tillman's lawyer told Davis that Warlander does hold credit default swaps tied to bonds being challenged, when asked the question directly by the judge.

State spreads have widened by as much as 35 basis points since the lawsuit's filing. Appeals are expected, no matter what the judge rules.

In general the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so avoiding losses caused by price volatility by holding them until maturity is not possible.

Lower-quality debt securities generally offer higher yields, but also involve greater risk of default or price changes due to potential changes in the credit quality of the issuer. Any fixed income security sold or redeemed prior to maturity may be subject to loss.

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