CHICAGO — The Chicago Public School system is facing headwinds as it returns to the bond market next week, stung by back-to-back negative headlines.
The news reports include the disclosure of a federal probe into a no-bid contract to a firm with ties to the district's chief executive officer and comments from freshman Gov. Bruce Rauner that raised bankruptcy as an option for the district.
The headlines "hurt valuation" and "impact reception," although the bottom line for "savvy investors is the fundamental credit quality," said Robert Miller, senior portfolio manager for Wells Capital Management.
After selling floating rate notes, the Chicago Board of Education late last month pushed off the second piece of its financing — about $300 million of new money bonds — to April 21 to let the market digest a round of multi-notch downgrades that triggered swap termination events.
The district also was concerned that market jitters over the April 7 mayoral run-off could hurt the sale. Mayor Rahm Emanuel won the contest. Sources said the city also wanted to complete a reoffering of some variable rate paper first.
The senior managers are PNC Capital Markets LLC and BMO Capital Markets. The district's 10-year GOs — rated from the low triple B category to low single A category — are currently trading at a 250 basis point spread to the Municipal Market Data's top-rated benchmark.
On Tuesday, Rauner who backs adding a Chapter 9 provision to Illinois statutes raised the specter of a potential bankruptcy as the district grapples with a $1.1 billion deficit, driven in part by growing pension funding woes in the form of a $700 million payment due in the next fiscal year. The district is saddled with $9.5 billion of unfunded pension obligations.
On Wednesday, questions over the district's leadership were raised after CPS disclosed it was the subject of a federal probe. Sources say a grand jury is reviewing evidence from the investigation into a $20.5 million, no-bid contract the district gave to a company and what role CPS chief executive officer Barbara Byrd-Bennett played in the decision. Bennett previously worked for the company -SUPES Academy — which trains principals.
The district released no details of the investigation and the U.S. Attorney's office wouldn't comment, though the company confirmed the investigation.
Bennett's contract expires in June and Mayor Rahm Emanuel, who appoints Chicago Board of Education members and handpicks the CEO, said he didn't know any details. "I'm as eager as you are for answers to questions," he said.
When asked if Bennett still enjoys his confidence, he said: "I can't answer, I don't even know who they are looking at." Bennett was serving as an advisor to Emanuel's first CPS CEO Jean-Claude Brizard before being elevated to CEO after Brizard's ouster in October 2012 following a teachers' strike.
The governor's comments came during a Chicago Public Education Fund luncheon. "The state has a crisis, the city has a crisis. I'm concerned that [CPS] is going to have to go bankrupt," Rauner was quoted as saying. The "bankruptcy code exists to help the organization get out of financial trouble." He added that such a move would allow the district to restructure its "debt and contracts," according to reports in the Chicago Sun-Times and the education publication Catalyst that was later confirmed by Rauner's office.
"The taxpayers of Illinois are not going to bail out the city of Chicago, that ain't happenin'," Rauner said during a meeting with downstate superintendents Thursday according to the Chicago Tribune.
The freshman governor's comments come as the district is headed into teacher contract negotiations. Rauner proposed adding a Chapter 9 statute to the state's laws as part of his "turnaround agenda," providing local governments with more leverage in negotiations with unions.
"The governor believes that bankruptcy should be an option to help turn around school districts. That decision belongs at the municipal level — not the state," the administration said in a statement Wednesday.
"They are a long way away from Detroit, but the governor's comments don't help," Miller said. "As a bondholder bankruptcy is not something you want to hear. It's a negative for the credit."
Investors will be looking at whether the federal probe is likely to affect credit quality.
Miller said he's seen a lot of investor repositioning ahead of the sale in secondary trades, as some may be shedding CPS debt to make room for the new issue while others could be dropping exposure.
Brian Battle, director of trading at Performance Trust Capital Partners, investors might be willing to overlook the governor's comments. "They understand that Illinois is a state that is very difficult to govern and with a new governor there will a lot of posturing on both sides," he said.
The federal probe could prove a wild card as investors look for information on its scope and how it will impact the district's administration. "If you've got management under federal investigation, it has to be disclosed," Battle said.
City and CPS officials were quick on Tuesday to respond that they were not interested a bankruptcy option. They also said a pending bill sponsored by a Republican lawmakers allowing for Chapter 9 hasn't gained much traction in the Democratic controlled General Assembly.
CPS may face an uphill battle to solve its budget strains. It has little revenue flexibility under state property tax caps, has nearly drained its reserves to deal with past budget gaps. Its reliance on one-shots like debt restructuring, reserves, and other maneuvers have contributed to its steep credit slide.
Emanuel and CPS officials are pressing for state legislative support for easing the CPS pension burden, arguing that local taxpayers are penalized by having to pay property taxes toward Chicago teachers' pensions and income taxes that support the state teachers' fund.
The district's budget strains resemble its situation from a few decades ago. With the district facing fiscal insolvency in 1979, the state stepped in and created an oversight panel that controlled CPS finances and issued debt on its behalf until control was handed over to former Mayor Richard Daley under reform legislation in 1995. Several school districts are currently under state financial oversight.
The CBOE completed the sale of two floating note tranches, each for about $89 million, to refund variable-rate paper on March 24, paying a steep penalty for its credit woes in a rate of 4.02%.
The finance team is promoting the bonds' strong alternate revenue pledge of state aid on top of a general obligation pledge, and its liquidity should it be called up on to cover swap terminations. The termination event was triggered when both Moody's Investors Service and Fitch Ratings lowered the district's GO bonds below the BBB level.
The district's 10 interest rate swaps on a notional amount of $1.1 billion of paper carry a current negative valuation of $228 million. The district says it has liquidity of $174 million in a debt service stabilization fund, an expected ending balance of $227 million, $211 million in credit lines, and $500 million in a revolving tax anticipation note line.
CPS is negotiating with the counterparties to stave off payments, but has not responded to requests for an update on the negotiations.
Moody's on March 6 downgraded the board's $6 billion of GOs two levels to Baa3 and assigned a negative outlook. Ahead of the new sale, the board did not seek a rating from Moody's. It sought fresh reviews from Fitch Ratings and Standard & Poor's and a new rating from Kroll Bond Rating Agency.
Fitch on March 20 lowered the district's GOs to BBB-minus from A-minus, assigning a negative outlook. Standard & Poor's lowered the district's rating by two notches to A-minus and assigned a negative outlook. Kroll assigned a first-time rating of BBB-plus with a stable outlook.
The district's 10 year paper is trading at a 250 basis point spread to MMD while it's 15-year bonds trade at a 300 basis point spread, Battle said. That compares to Chicago, which carries ratings from Baa2 to A-plus and is seeing its 10-year paper trade at 200 basis points over MMD and its 15 year paper trade at a 250 basis point spread.
