Chicago Public Schools' junk paper an easy sell for market
With two upgrades in tow and the ink signed on a new budget, Chicago Public Schools further chipped away at its yield penalties in a refunding issue this week that fully shed its floating-rate risk.
The junk-rated district sold $349 million of fixed-rate bonds Thursday to refund 2008 paper in two series with the books run by JPMorgan. A $225 million tranche offered maturities from 2027 to 2030 and included $62 million of capital appreciation bonds added ahead of the pricing due to demand. The discounted cabs matured between 2025 and 2027. The $124 million series offered maturities between 2021 and 2033.
The district said the deal was more than seven times oversubscribed and “saw broad investor support with orders from 41 institutional buyers, which is a significant change from recent years when the district's financial situation was more uncertain.”
The nine- and 10-year bonds with a 5% coupon landed at 2.63% and 2.68%, respectively, after a repricing that shaved five basis points off the yields.
That represented a spread to the Municipal Market Data AAA benchmark at the market’s close the prior day of under 150 basis points, a more than 70 basis point improvement from the last sale in December when a comparable nine-year bond settled at a 221 basis point spread.
A separate nine-year bond insured Assured Guaranty Municipal Corp. landed at a 127 basis point spread. A 2046 uninsured bond in the deal saw a spread of 211 basis points.
The district paid a punishing 480 basis point spread on its long 29-year bond in a GO sale just ahead of the mid 2017 passage of new state aid.
“Tighter spreads show how the market has grown more aggressive generally, but there’s clearly some specific momentum behind prices for Chicagoland borrowers, probably as a bet on a more benign relationship with the state,” said Matt Fabian, partner at Municipal Market Analytics. “Or maybe it shows how CPS can bring a new issue without the Illinois governor trying to talk the bonds down in the teeth of the pricing.”
The latter was a reference to former Gov. Bruce Rauner’s comments on several occasions that CPS was a good candidate for bankruptcy. The comments came ahead of pricings that rattled the market even though the state lacked such a provision and Democrats, who held a legislative majority, were opposed.
The combination of the district’s improved credit standing and demand for high-yield paper was a positive, said Triet Nguyen, founder and managing partner of Axios Advisors LLC. “In this market that’s an attractive spread and I think there’s a general perception that CPS at least has better support from the state and city.”
The sale’s proceeds were used to purchase the 2008 bonds that had been privately placed with Dexia and were tendered at a discount. “Despite the investor receiving less value than the promise of the original securities, we do not view this offer as a distressed exchange but rather purely opportunistic given the board's improving credit quality and the exchange was not initiated due to distress or inability to pay,” S&P Global Ratings said.
About $20 million of savings was achieved for fiscal 2020 budget relief.
“Today's successful refinancing, which eliminated all long-term variable rate debt from the district, is further recognition of the financial turnaround CPS has made since facing a nearly billion dollar deficit just over two years ago. CPS is fully committed to building on its financial progress so it can continue to support the investments that have helped our schools reach record levels of academic success,” said CPS spokesman Michael Passman.
Two years ago floating-rate bonds made up about $1 billion of the district’s $7 billion GO debt load. After the board opted not to remarket some series when their remarketing, or expiration dates, came due, rates on some of the portfolio shot up to a maximum fixed rate of 9%.
The deal came to market with tail winds from an upgrade last week to BB from BB-minus from Fitch Ratings with a stable outlook assigned and an upgrade to BB-minus from B-plus from S&P, which assigned a positive outlook. Each is still several notches away from investment grade.
The market initially responded with a narrowing of spreads with a 10-year bond at a 135 spread compared to a prior one of 187 basis points and an 11-year bond down to 135 from 190, said Edward Lee, strategist at IHS Markit.
Moody's Investors Service rates the district B2 and Kroll Bond Rating Agency, the sole agency to rate CPS GOs at investment grade, rates the district’s GOs BBB and BBB-minus, depending on the series, with a positive outlook.
The board of education at its Aug. 28 meeting signed off on a $7.7 billion budget that authorizes $821 million of capital spending primarily funded by borrowing and the new state infrastructure program.
Additional aid and pension help in 2017, along with new and higher local tax levies between 2016 and 2017, helped the district whittle down a $1 billion deficit. While budget pressures have eased and reserves are being rebuilt, the district’s liquidity woes continue and its reliance on short-term borrowing to manage operations, spending pressures, and unfinished labor negotiations are concerns for investors and rating agencies.
The Chicago Civic Federation supported the budget despite ongoing concerns about its long-term fiscal prospects. “The downward trend in enrollment, uncertainty regarding labor negotiations and various other pressures bear careful watch as they could put the district’s hard-earned financial stability and educational gains in jeopardy,” said Civic Federation president Laurence Msall.
Any further climb up the speculative grade ladder could be driven by the final deal struck with the Chicago Teachers’ Union, the first major test for the new administration of Mayor Lori Lightfoot.
“Upon a successful settlement, a higher rating is possible. A successful settlement, in our view, would neither create a budget gap nor disrupt the board's recent financial progress. In our view, any agreement that materially increases expenditures beyond anticipated revenue growth, is a credit negative,” S&P said.
The Chicago Teachers Union has slammed district offers on raises and wants a commitment in the contract on additional school nurses and social workers, librarians, and smaller classrooms built into the contract. CTU delegates set a date of Sept. 26 to tally a strike authorization vote with Oct. 7 being the earliest a strike could be called.
The district also announced the departure of Ronald DeNard, senior vice president of finance. The district said it is looking to fill DeNard’s position. The district lost its chief financial officer in the spring when Jennie Huang Bennett took over as the Chicago CFO. Walter Stock was elevated over the summer to treasurer and deputy chief financial officer.
“Ron joined CPS when the district’s financial situation was dire, and he played a crucial role in stabilizing our finances so that we can invest in high quality instruction in all parts of the city. I thank Ron for the leadership he has provided to CPS and wish him future success in his new role,” chief executive officer Janice Jackson said in a letter to CPS staff.