Chicago teachers strike raises pressure on district and city

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Chicago Public Schools teachers walked out Thursday, raising the fiscal stakes for the junk-rated school district.

Municipal market participants are watching for the effects of the strike and outcome of contract negotiations on both the schools and the city because their fiscal and credit fortunes are linked.

The district's slow fiscal progress could be threatened by too costly a contract and the city can ill-afford much financial assistance as it grapples with its own $800 million deficit.

CPS operates 659 schools that serve 361,000 students making it the third-largest public district in the nation.

The fiscal pressures posed by the strike come as the Chicago Board of Education is scheduled to competitively sell $250 million of tax anticipation notes on Tuesday followed by first-year Mayor Lori Lightfoot’s unveiling on Wednesday of a 2020 budget proposal that will detail how she intends to solve the gap.

“The city has enough problems just trying to get rid of an $800 million deficit” and now “you have teachers wanting to go on strike. It’s going to cost the city more money to settle,” said Howard Cure, director of municipal research at Evercore Wealth Management.

While the buyside and rating agencies will gauge the cost of any deal on the district’s balance sheet, the bigger issue at hand for investors is the city budget and whether it will also have to step up to help the district. Chicago’s mayor appoints the board of education and handpicks the chief executive officer.

Property taxes, state aid and federal funds make up the bulk of the district’s budget. Tax hikes are capped and aid is set by various formulas, so revenue options are limited.

“The market is waiting to see how the mayor is going to deal with the budget, so having the strike now and whatever financial hardships the city could face in order to settle it is another question mark. It’s bad timing,” Cure said.

Longer-term issues are in play too. Cure warns that a prolonged strike coupled with other issues like crime worries that dominate local headlines raise the specter of population loss.

“The longer they are on strike the more frustrated people will get with the school system,” Cure said.

The district has little breathing room as new state aid could face cuts in the event of an economic downtown that further strains state finances. That’s especially a worry if Gov. J.B. Pritzker’s proposed constitutional amendment to shift to a progressive income tax fails in November 2020.

The district won two upgrades ahead of a September general obligation sale: to BB from BB-minus from Fitch Ratings, with a stable outlook, and to BB-minus from B-plus from S&P, which assigned a positive outlook.

Further movement upward could be impacted by the final contract’s cost.

“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 in a recent report.

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.

Kroll in a statement Thursday said it will comment once settlement is reached. "KBRA’s analysis will focus on the cost of the contract, potential reductions in state-aid depending on the duration of the strike, and how CPS closes associated current year budget gaps, if any," it said.

Just ahead of the strike announcement, Municipal Market Analytics warned heavier trading and volatility are possible for Chicago city and Board of Education bonds in the near term, but MMA doesn’t see the strike necessarily as a negative.

MMA views as positive the board and city’s refusal to automatically approve the Chicago Teachers Union’s demands. “Still, the start of a strike would generate negative headlines and could see related selling/ widening in bonds, presenting a limited buying opportunity for accounts already comfortable with the name,” MMA warned in its weekly outlook.

Lightfoot, who took office in May, likely will rely for her city budget on a mix of fixes with some recurring improvements like spending cuts, modest tax hikes away from the property tax as well as some one-time savings like more scoop-and-toss of debt service — and some gimmicks, the largest of which may be a gamble on more state assistance, MMA said.

“Let’s hope no [pension obligation bonds], but base case expectations should be for stability in both ratings and spreads,” MMA said.

Strike issues
The last strike occurred in 2012 and students missed seven days.

The city has offered a 16% raise over five years. Lightfoot said Wednesday that the teachers are demanding another 5%. The union wants more teacher preparation time, but the city and CPS say it can’t come at the cost of instructional time because it would backtrack on the longer school day that Lightfoot's predecessor, Rahm Emanuel, pushed.

The biggest sticking points between the two sides are differences over whether policy issues on class size, staffing, librarians, and counselors and nursing requirements are built into the contract. Lightfoot and schools chief Janice Jackson want to fund some of the demands in the budget, but the CTU wants a contractual obligation. The union also wants the district to address affordable housing issues and student homelessness.

Lightfoot said all the demands would cost the district $2.5 billion. “CPS is just removed from being on the brink of insolvency. We have made a lot of progress with the CPS finances shoring them up, but we are not out of the woods,” Lightfoot said after Wednesday’s City Council meeting. “We don’t have an unlimited amount of resources to accommodate every request.”

The CTU counters that the district’s infusion of new state and tax funding makes the timing right to address the issues it’s promoting and that the city could come up with more money if it were to end some tax increment financing subsidies or impose a so-called LaSalle Street tax on financial transactions.

“Mayor Lightfoot has the power to ensure that the equity and justice she promised our students as a candidate becomes the norm and not the exception in our schools, yet she's failed to bring those values to the bargaining table," said CTU President Jesse Sharkey. "We intend to bargain until we get those commitments in writing in an enforceable contract."

The notes
The unrated notes mature March 20 and are secured solely by the district’s $2.5 billion of fiscal 2020 property tax receipts.

The district has relied heavily on TANs to manage operations although it did cut the amount of notes outstanding at any time down to $845 million in fiscal 2019 from a high of $1.55 billion three years ago.

Property tax receipts that secure the notes go directly from the county collector to an escrow agent. The collection rate has historically been around 97%.

Rates on the district’s last competitive cash flow note sale landed at 1.95% and 2%. The district paid punishing rates of 4.8% in prior fiscal years.

The four pages of “investment considerations” in the offering statement underscore the district’s fiscal progress and hardships.

An “extended” strike could trigger state cuts unless days are eventually made up. The district has not announced plans to do so. The district outlines how it relied on one-shots like the use of reserves, debt restructuring, and short-term borrowing to manage structural deficits that ran as high as $1.1 billion over the last six years.

New state aid and pension funding along with a series of city property tax levies for pension and capital helped cut the deficit, bringing the district back from the brink of insolvency. The district had in 2016 and early 2017 nearly exhausted its available one-time fiscal maneuvers and was nearly locked out of the market by interest rate demands as former Gov. Bruce Rauner called the district a candidate for bankruptcy although the state does not permit Chapter 9 filings.

“The board’s ongoing financial outlook will continue to be determined by factors such as labor, pension, and debt service costs as well as the ability of the board to raise revenue and reduce certain expenditures,” says the note offering statement, which goes on to warn that revenues are set by tax caps and state appropriations and expenses governed by bargaining contracts.

The district intends during the 2020 fiscal year to borrow an additional $250 million of TANs in December, $100 million in January, $350 million in February, $200 million in May, and $250 million in June. While much of the year is spent in negative cash flow, the district reports that it will spend non-consecutive days totaling about five months without any notes outstanding.

In September, nine- and 10-year CPS bonds with a 5% coupon landed at spreads of 150 basis points to the Municipal Market Data AAA benchmark, an improvement of more than 70 bps from its sale last December. 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.

MMD municipal strategist Daniel Berger said he’s seen little trading of CPS GO paper since the board’s last sale.

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.

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