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UPDATE 2-Illinois sells first $1.5 bln of bonds to pay overdue bills

(Adds yield and spread for 2019 bonds, comments from governor's office)

CHICAGO, Oct 17 (Reuters) - Illinois on Tuesday sold the first $1.5 billion of a planned $6 billion of tax-exempt debt in the U.S. municipal market with mixed results.

The state will sell the remaining $4.5 billion of general obligation bonds through a team of underwriters next week. Proceeds are earmarked for paying off a huge pile of overdue bills from vendors and service providers that are accruing late payment penalties of as much as 12 percent a year.

The three-part debt sale resulted in an overall borrowing cost of 3.5 percent, according to Governor Bruce Rauner's office. The state received strong bids today for its bonds and is pleased with the markets favorable reception of the sale, Scott Harry, Illinois' budget director, said in a statement. This bodes well for the states financing coming next week.

The yield penalty the market assigns to the lowest-rated U.S. state for its short-term bonds eased considerably in Tuesday's pricing, while the penalty for 12-year bonds largely stayed intact.

In competitive bidding, Bank of America Merrill Lynch won $500 million of bonds due in 2018 that were "aggressively" priced with a 1.64 percent yield, said Greg Saulnier, a Municipal Market Data analyst. That yield narrowed Illinois' spread over MMD's benchmark triple-A yield curve to 70 basis points from 100 basis points ahead of the sale.

J.P. Morgan Securities won $500 million of 2019 bonds with a 1.70 percent yield that dropped the spread to 69 basis points from 125 basis points on Monday.

BofA also won $500 million of bonds due in 2029 with a yield of 3.78 percent, which slightly increased the spread over the scale to 165 basis points from 163 basis points, according to MMD, a unit of Thomson Reuters.

"Overall the bonds priced pretty good," Saulnier said.

The state received nine bids for each $500 million series of bonds, which carry 5 percent coupons, according to the governor's statement.

An impasse between Illinois' Republican governor and Democrats who control the legislature left the state without complete budgets for two fiscal years and ballooned the bill backlog to a record $16 billion.

The legislature in July enacted a fiscal 2018 budget that included the bond authorization, as well as an income tax hike over Rauner's vetoes. The action helped Illinois avoid credit rating downgrades that would have made it the first state to fall into the junk level. (Reporting by Karen Pierog; Editing by Matthew Lewis)