Chicago, CPS, Illinois All Testing Their Credit in Primary Market

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CHICAGO – The lack of supply to meet demand – especially for yield – will benefit Chicago, Chicago Public Schools, and Illinois when all three fiscally distressed credits land in the bond market this month, market participants say.

Chicago prices $500 million Tuesday in a negotiated transaction led by Citi and Illinois takes competitive bids on $480 million Thursday. Both are part of a more than $8 billion muni primary calendar this week.

CPS was expected to sell $1.2 billion as soon as the week of Jan. 18 with JPMorgan at the helm, but the deal has pushed back to the week Jan. 25, market participants said Monday.

All are general obligation issues.

"It's a great time to be a distressed borrower," with supply falling short of investor demand, said Chicago-based Brian Battle, director of trading at Performance Trust Capital Partners.

"There's a strong wind at the back of municipal issuers," said Matt Fabian, partner at Municipal Market Analytics, though the distressed credits, particularly Chicago Public Schools, pose a tough distribution task for underwriters. Seasonal inflows and a flight to the safety of Treasuries and the municipal market work in the issuers' favor, he said.

The market will have about $2.3 billion of Illinois paper from high profile borrowers to digest this week, as two higher-rated credits – the Regional Transportation Authority of Illinois and the Illinois Housing Development Authority – are also slated to sell.

Market participants said they don't expect any of the credits to suffer from the deals' overlap. While they share some of the same buyer base, they are distinct enough credits, with Illinois' sovereign powers and Chicago still attracting traditional investors despite its credit deterioration. Both will offer premium yield penalties for their credit woes in the face of negative outlooks that suggest more rating blows lie ahead that would hurt their bonds' value and dent their investor base loom.

"Illinois is an easier sell. The risk of the state actually defaulting is minimal," Fabian said. On Chicago, investors do have a more positive view of the city's name since its passage of a big property tax hike to pay for rising public safety pension contributions, although political and legal actions that loom on its pensions stand to influence its fiscal condition.

"Everyone can buy Illinois," Battle said.

"We believe the depth of the market for all three names is likely more shallow than it has been in the past as more participants begin to view each of these as speculative grade credits," said Thomas Schuette, co-head of credit research at Gurtin Fixed Income Management. "However, given that the market is starved for supply, especially in the high-yield space, we would expect that each is likely able to find buyers without paying the sort of credit penalty they probably should."

CPS' severe liquidity distress, headlines over the insolvency that appears to be looming if it doesn't receive state help, and position deep in junk bond territory is a tough sell for buyers, with the investor tone set on Chicago's deal expected to provide price guidance the CPS sale.

One market source said the week's delay in the school district deal was probably a smart move for both the city and CPS, giving the city's deal more time to clear the market before CPS appears front and center.

"I don't know it's clear who the buyers for CPS will be," Fabian said. High-grade buyers won't participate and taxable high-yield buyers are distracted by turmoil in the oil and commodities markets.

Market participants agree that JPMorgan and the board of education's finance team would not bring the deal unless it was clear that most of the bonds could be distributed, so the question is at what cost.

"What rate will you take" to build a book, Battle said. The district's close ties to the city should help placement with the view being that to curry favor with Chicago Mayor Rahm Emanuel, underwriters will step up on the schools deal. 

The higher-grade names will continue to pay yield penalties long imposed by the market for the Illinois name but Schuette said he doesn't expect they will be materially hurt by timing.

After the dust settles on the sales, participants will be watching for the impact on secondary trading levels.

"If high-yield buyers drive demand up for these names, we would not be surprised to see yields come in and the secondary reset off of what happens with the primary deals," Schuette said.

Chicago has recently been trading at about a 250 basis point spread to top-rated Municipal Market Data yields while Illinois has traded at about 170 to 180 basis points and Chicago school bonds have traded at more than 350 basis points over MMD.

Since Illinois' last GO bond sale in May 2014, Fitch Ratings and Moody's have downgraded the state, from A-minus and A3 respectively to BBB-plus and Baa1. Fitch assigns a stable outlook, Moody's a negative one. Standard & Poor's has affirmed its A-minus GO rating and assigned a negative outlook.

A pre-marketing scale on Chicago's deal circulated Monday offered a 10-year serial at 4.35%, 260 basis points over triple-A MMD and 167 over other triple-B-rated credits. A 22-year bond offered a yield at 4.95%, 240 basis points over the AAA scale and 151 basis points over BBB credits.

The city carries a junk-level rating of Ba1 from Moody's, with a negative outlook; BBB-plus ratings from both Fitch Ratings and Standard & Poor's with both assigning negative outlooks; and is rated A-minus with a stable outlook by Kroll Bond Rating Agency.

Since Illinois' last GO bond sale in May 2014, Fitch Ratings and Moody's have downgraded the state, from A-minus and A3 respectively to BBB-plus and Baa1. Fitch assigns a stable outlook, Moody's a negative one. Standard & Poor's has affirmed its A-minus GO rating and assigned a negative outlook.

Moody's Investors Service recently downgraded the Chicago Board of Education one more notch into junk territory, to B1 from Ba3. Moody's kept the credit under review due to headwinds bearing down on the district over the next 90 days. S&P assigns a BB rating and Fitch assigns a BB-plus rating. Both have the rating on negative watch which implies more near-term risks.

The district retains the lowest investment grade level rating from Kroll Bond Rating Agency.

Chip Barnett contributed to this story

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