Chicago Yield Penalties Steepen

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CHICAGO -- Chicago's spread penalties in the primary market hit a new peak Thursday when it priced a $1.2 billion general obligation sale.

The city's tax-exempt spreads landed at 339 to 347 basis points over the Municipal Market Data's AAA benchmark.

That compares to 229 to 253 basis points when it sold GO bonds a year ago. The city's primary spreads hit 293 basis points on a 2015 bond issue, shortly after Moody's Investors Service slapped a junk-bond rating on the city.

The city has paid a costly penalty for its financial struggles in recent years. In 2012 before its ratings tumbled, the city's spreads were just under 100 basis points.

This week's deal offered $889 million of tax-exempt paper and $274 of taxable securities. Goldman Sachs ran the books.

The deal was nearly three times oversubscribed with 145 investors participating, city financial department spokeswoman Molly Poppe said. The city has no additional GO borrowings planned until 2019.

"The city continues to address our financial challenges and work to end bad financial practices of the past, and these bonds represent a critical milestone in this effort," Chicago's chief financial officer, Carole Brown said in a statement.

"This deal represents our final borrowing for scoop and toss, following through on Mayor Emanuel's commitment to end this practice by 2019. This is also our last borrowing for routine settlements and judgments, continuing the mayor's commitment to end the legacy of using long-term debt to pay for operating expenses."

Both are much-maligned practices the city began under former Mayor Richard M. Daley and continued under Emanuel.

Market participants said budget and pension funding gains that prompted three rating agencies to shift the city's outlook to stable from negative were overshadowed by market jitters over Chicago Public Schools' fiscal distress and the state government's budget mess.

The city's spat with Moody's Investors Service, asking it in a December letter to withdraw its ratings, didn't help; a rough market; and uncertainty over what lies ahead under a Trump administration also may have contributed to the wider spreads.

"This is the worst spread the city has seen," said Matt Fabian, partner at Municipal Market Analytics. "They are coming to market right in the teeth of the inauguration when investors are worried about tax exemption and inflation risks and no one knows what the administration will or can do."

Investors also are more closely linking Chicago and CPS.

"I don't think the market views the city's credit as weaker; it's just more inclined to tie the city to Chicago Public Schools and the state," Fabian said.

"It was a tough market to bring a deal," said Brian Battle, director of trading at Performance Trust Capital Partners. "It's a billion dollars and Chicago has a narrow customer set. They had to come cheap."

Battle said the spreads reflect a combination of a weaker market with Treasuries selling off, the headlines over the mayor's spat with Moody's, and CPS and the state weighing on investors' minds.

The city's story is complicated, Battle said.

"It's a vibrant city with a highly distressed school district in a state that doesn't have a budget and its General Assembly is at war with the governor," he said. "What's the cost? 350 basis points."



Chicago's shortest bond in the tax-exempt piece -- a 12-year 2029 maturity – landed at 5.80% with a 5.625% coupon, 347 basis points over MMD's AAA benchmark of 2.33% at the market's opening, and 248 basis points over the BBB benchmark.

Aside from Moody's junk Ba1 rating, three other rating agencies have Chicago in the triple-B range.

The bulk of the sale – $711 million -- was offered in a 2038 maturity that landed at a yield of 6.20% with a 6% coupon, 339 basis points over the comparable AAA rate of 2.81%, and 241 basis points over the BBB.

The high coupons reflect the city's need to cater to specific investor requests by offering a discounted price. In order to raise sufficient proceeds, however, the city has to in turn raise the coupon, said one market participant who likened it to what you see on more distressed credits like the Chicago Board of Education whose GOs have been trading at a 450-basis-point spread.

On its last tax-exempt GO sale for $500 million in January 2016, the 10-year rate of 4.31% on the 2016 sale represented a spread of 253 basis points to the AAA and 159 basis points over the triple-B.

The deal's long 22-year maturity yielded 4.875%, 229 basis points over the triple-A benchmark and 139 basis points over the triple-B. The deal offered 5% coupons.

The 2016 sale followed passage of a $543 million annual property tax hike to fund higher contributions to the city's public safety pension funds, which many said drove a tightening of spreads from the previous issue in July 2015.

The city did not offer a 10-year maturity on its $1.1 billion July 2015 deal, but the nine-year maturity landed at 5.09%, 290 basis points over MMD's AAA and the long bond in 2039 landed at 5.69%, 252 basis points over MMD.

In the GO sale in late May 2015 soon after being junked by Moody's, Chicago saw spreads of 293 basis points on its 10-year maturity and 264 basis points on the longest 27-year maturity.

In a March 2014 sale for $880 million, which marked Chicago's first after being stung by two three-notch downgrades in 2013, the city's 10-year tax-exempt maturity paid a yield of 3.95%, a spread of about 145 basis points, and the long bond in 2036 paid a yield of 5.18%, 161 basis points over MMD. The city then carried ratings of between Baa1 and A-plus.

The city did not issue GOs in 2013, but in its May 2012 its 10-year maturity priced at 84 basis points over MMD and a 22-year maturity at 89 basis points over MMD.

This week's $274.26 million of taxable paper was priced as a 2029 bullet maturity at par to yield 7.47%, about 457.5 basis points over the comparable Treasury security with a make-whole call.

The city's last taxable issuance in the July 2015 sale did not offer a 12-year maturity to compare directly with this week's sale, but the eight-year bond landed at a 400 basis point spread. The city's 30-year taxable coupon ended at 265 basis points over Treasuries in the March 2014 sale.

Ahead of the sale, finance officials traveled to New York City and Boston for investor meetings hoping to keep its spread penalties in check. Since its last sale, the city raised taxes as part of a plan to rescue its two other pension systems, and trimmed its structural budget deficit.

Emanuel has acknowledged more work lies ahead because the city's budget gaps are projected to grow if the economy falters and new revenue must be found when actuarially required contributions begin in 2021 under the city's pension fixes, but the mayor contends the city has turned the fiscal corner.

At the same time, CPS' woes have intensified despite winning some additional state funding and the state's prolonged budget impasse shows no firm signs of easing.



The city headed into a choppy market Thursday as rates were headed up.

The top rated MMD 10 year was at 2.17% Thursday heading into the sale compared to 1.78% on the day the city headed into the market in January 2016. Treasury yields heading into the city's last taxable deal in July 2015 were at about 2.35% on the 10-year, while heading in this week they were at about 2.39%.

With post-election yields up since near record lows over the summer, some investors may be less willing to take on Chicago's headline risk with yield available elsewhere.

For Chicago, which already has a narrow buyer audience, any pullback hurts, said several market participants.

Other market factors could also be at play.

"Liquidity has become more important" since outflows began after the election, Fabian said. "Chicago bonds are some of the lease liquid because of the headline risk."

Secondary market trading of Chicago's tax-exempt paper has fluctuated over the last year between 200 and 350 basis points depending on credit actions and headlines. MMD said it had seen recent blocks of trades of the city's 15-year bonds with 5% coupons trading at a 310 to 320 basis-point spread.

Proceeds of the sale will fund the city's 2016 and 2017 capital program and portions of the city's aldermanic project menu; refund debt for savings, cover capitalized interest with $225 million covering settlements and judgments and $440 million being used to restructure some debt coming due.


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