CHICAGO – The Chicago Public Schools doubled the size of its planned $250 million unrated general obligation bond deal Monday as high yield buyers were drawn by attractive rates and an added security feature.
JPMorgan ran the books on the sale.
It was originally slated for $250 million in two series, one for $200 million of new money and the other for $50 million of restructuring bonds that push off debt service, but the school board had authorized up to $500 million.
The first series was boosted to $285 million. The preliminary pricing wire showed the term bond maturing in 2046 offered a yield of 7.75% with a 7% coupon and price of $91.346. The second tranche was raised to $215 million with a $75 million maturity in 2030 and a $140 million 2042 maturity that offered coupons of 6.75% and 7% respectively with yields of 7.25% and 7.60% and prices of $95.751 and $93.282.
Municipal Market Data said the 7.25% yield represented a 488 basis point spread to the MMD’s top-rated benchmark, the 7.60% represented a 480 bp spread, and the 7.75 % represented a 490 bp spread based on comparable maturities, according to MMD’s market close.
"CPS successfully completed the issuance of its GO bond offering, with more than $1 billion in orders for $500 million in bonds," Ron DeNard, the district's senior vice president of finance, said in a statement. The district received a total of $1.1 billion in orders. "The bonds priced between 7.25% and 7.65%, depending on maturity, a reduction in financing costs from the district's bond offering last year."
The district put yields at between five and 10 basis points lower on two maturities compared to the last available pricing wire. It listed the 2030 maturity at 7.25%, the 2042 maturity at 7.55% and the 2046 maturity at 7.65%.
Alan Schankel, managing director at Janney, said that the deal was cheap enough to get the attention of yield buyers, which explains the doubling of the deal size. “The security (pledged state aid), would be considered strong for most other states, but Illinois’ longstanding and growing fiscal challenges as well as recent track record of political intransigence, add a layer of risk for investors,” he said.
The break in the state budget impasse last week might also have helped the deal.
"CPS' financial position was improved with the Illinois budget," added Brian Battle, director of trading at Performance Trust Capital Partners. Passage of the budget will eventually allow the state to get block grants to the district more quickly and could result in more operating and pension help.
The yields are punishing and eye-popping for a tax supported GO but represent an improvement over CPS’ last public offering of GOs early last year that landed at 8.5%, near a state imposed cap of 9%, said one Chicago-based trader.
A new security feature and bond opinion on one tranche as to the “special revenue” status of the B bonds “made the deal possible,” said the trader. “It sounds like they were in negotiations with some buyers and that resulted in the security features” and JPMorgan came Monday with its book of orders locked down and pricing details aimed at catering to demand.
The non-rated structure also helped because some buyers could participate who are not allowed to hold non-investment-grade paper.
“It allows buyers to put their own internal rating on it,” the trader said. The offering statement warned of the “high degree of risk” for the unrated bonds that were available to only qualified institutional buyers that could bear the risks.
As part of the deal, prior to delivery of the bonds the district agreed to enter into a state aid revenues escrow agreement. It sets up two accounts, a general one and a security one with all unrestricted state aid funds deposited into the general account. Pending board adoption, the state comptroller would be directed to deposit those funds directly to the escrow agent.
CPS retains the ability to withdraw funds “at its discretion” from the general account unless there is a default. If a default on debt service principal, interest, or sinking fund installments and it’s not cured within 10 days, the general account funds then are transferred to the security fund and additional revenues continue to flow there.
The security fund is pledged as security for bond repayment. The board does not offer an opinion on the status of the account in the event of a bankruptcy.
On the B bonds, the deal’s bond counsel Katten Muchin Rosenman LLP provided an opinion letter that it believes the pledged revenues would qualify as “special revenues” insulating them should the district find itself in Chapter 9. Illinois lacks bankruptcy provisions for local governments but Republicans, including Gov. Bruce Rauner, support adding one. If the funds meet the special revenue definition they would be protected from bankruptcy’s automatic stay and should retain their lien status.
The pledged taxes have already been levied for the prior bond expenses and are “payable and secured by a valid lien upon and pledge of the pledged state aid revenues and the pledged taxes,” the opinion says. The district has traditionally abated the taxes but that action is needed to halt collection.
Kroll Bond Rating Agency had assigned a rating one notch higher at BBB to the board’s 2016 GOs due to such an opinion on the deal and its own legal internal assessment.
The bonds are secured with a general obligation, unlimited tax pledge which serves as the backup to the primary pledge of unrestricted general state aid. Other rating agencies have weighed in saying the mechanics of the general state aid pledge are too iffy to ensure a special revenue designation.
Proceeds of the A bonds will reimburse the district’s debt service stabilization fund for previous expenses. The scoop-and-toss restructuring will push off debt service due in December providing “cash flow and liquidity relief” while driving up longer term annual debt service costs, according to the offering statement. Swap termination fees are also being reimbursed.
The district had $6.8 billion of outstanding debt ahead of the sale and it already carried a $13.25 billion repayment tab with interests.
Loop Capital Markets and PNC Capital Markets LLC were co-senior managers and another three firms rounded out the syndicate. PFM Financial Advisors and Phoenix Capital Partners LLC advised the district. Katten and Cotillas & Associates were co-bond counsel.
The offering statement laid out the district’s dire cash position and its precarious borrowing capacity.
The district’s cash position declined from $1.3 billion in fiscal 2012 to $186.4 million at the close of fiscal 2017 June 30. The latter figure doesn’t take into account $1.34 billion of outstanding grant anticipation notes and tax anticipation notes that won’t fully be paid until March.
The district will continue to operate with a negative cash position and expects to rely on short term credit lines to fund its “operating and cash flow needs” in fiscal 2018 but “there can be assurance as to the terms on which the board will continue to be able to procure such funding, whether the board’s existing statutory borrowing authority will provide sufficient borrowing capacity, or if the market access will continue to be available to the board.”
The district’s available revenues to address a structural imbalance that has been whittled down from more than $1 billion with new property tax revenue and cuts is largely “dependent” on more state funding and expense cuts, with borrowing possibly needed to offset a shortfall.
The district has previously said it would limit short term borrowing to its current $1.5 billion authorization but in the offering statement said it may go up to its statutory cap of 85% of its fiscal 2017 tax levy of $2.37 billion.
CPS – which carries single-B ratings from the other three rating agencies -- headed into the deal facing a fresh downgrade over state payment delays and the district’s broader greater fiscal ills are threatening to drag the city down with it.
Moody's Investors Service last week put the district’s B3 general obligation under review for a possible downgrade, a move prompted the state’s prolonged delays in sending the district its share of categorical block grants. The state has made only one of four quarterly payments prompting the district to borrow $387 million last month against the $467 million it’s still owed.
The action applies to $5.4 billion of mostly general obligation-backed alternate revenue bonds. The agency doesn't rate all of the district’s debt after CPS, the city, and other related borrowers stopped asking for ratings on more recent sales.
“While the district may receive increased funding through the budget package currently being considered by the Illinois General Assembly, such increases may be insufficient to alleviate CPS's distressed financial position,” Moody’s warned. If the district doesn’t receive its block grants by Oct. 31, the grant anticipation notes convert to TANs.
An overhaul of state aid distribution policies has cleared the General Assembly but Gov. Bruce Rauner has threatened a veto. The district could see about $300 million in new funding from the bill. An overhaul of formulas must be adopted to free up the K-12 funding authorization for all districts in the new budget package.
“If there is no material increase in state support, Moody's will assess what kind of support, if any, may be provided by the city,” Moody’s wrote.
Those links and Mayor Rahm Emanuel’s pledge to help the district if state help falls short prompted Moody’s to put the city’s Ba1 rating, one notch below investment grade, on review for a possible downgrade, as well as various revenue credits.
“Continued uncertainty surrounding the school district's financial situation in the wake of the state's own budgetary pressures and an indicated commitment from the city's administration to staving off further deterioration in the district's finances suggest the possibility of more direct intervention by the city in the district's fiscal affairs,” Moody’s wrote.
CPS paid initial rates in the 6% range on recent grant anticipation notes and they will be reset at LIBOR plus 550 basis points, up from its tax anticipation rates of LIBOR plus 400 bp.
CPS paid a high yield of 8.5% early in 2016 -- with a big discount offered – for a spread on the 2044 maturity at 580 basis points over the top-rated MMD benchmark. CPS later entered into a private placement for $150 million of GO debt in July at a 7.25% rate.
Amid rising rates after the November election, it put off a GO sale late in 2016 and returned to borrow using a new credit backed by a freshly levied capital improvement tax. The 2046 maturity paid a yield of 6.25% -- at a discounted price – for a spread of 309 basis points over the MMD’s AAA.
-- Aaron Weitzman and Chip Barnett contributed to this story