Easing of credit fears boosts investors' desire for Chicago schools paper

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CHICAGO – The municipal bond market is more attracted to Chicago Public Schools yields than it is worried about the district's fiscal future.

That's the evidence displayed in the district's latest market foray Thursday, as it reaped the benefits of a yield-hungry market and eased concern about its finances.

The $560 million general obligation refunding will provide $30 million in fiscal 2019 budget relief, the district said after more than doubling the deal’s original size of $260 million and moving up the pricing by a few days to Thursday.

Investors scooped up the Chicago Board of Education's mix of junk-rated paper and Assured Guaranty Municipal Corp.-wrapped securities. The district saw its spreads to the Municipal Market Data benchmark on its 10-year narrow by 30 basis points and spreads on its comparable long bond narrow by 15 bp from a November GO sale.

“You have high-yield buyers who are looking to replace their tobacco bond holdings and the credit is obviously in a better place than six to 12 months ago,” said Lyle Fitterer, senior portfolio manager at Wells Capital Management.

More high-yield cash is becoming available due to tobacco refundings in New Jersey and California. The district’s last GO deal in November benefited from improved outlooks and an upgrade following approval of new state aid. While CPS is facing daunting long-term fiscal strains and faces a long road to exit junk-bond status, it is viewed as more stable and since the November sale another rating agency has raised its outlook to positive.

The insurance also attracted a more diverse range of buyers. “The market is comfortable with Assured and that was a way to get part of the deal done by bringing in a different set of buyers,” Fitterer said.

“I think they told an improving credit story this time and the market timing was good,” said Adam Buchanan, a senior president of institutional sales and trading at Ziegler. The district executed well with its use of insurance, its marketing and by upsizing the deal now, he said, to avoid higher rates down the line. “If you are looking at indicators six months from now you might have a different market.”

The board recently authorized up to $600 million in refunding bonds.

One market participant said concerns over the prospects for state budget gridlock took a backseat to demand for yield.

Some maturities were 10 times oversubscribed, CPS said, allowing the underwriters – led by Loop Capital Markets and JPMorgan – to reprice the bonds.

Strong demand seen in talks and meetings with investors prompted the district to move up the sale and the prospects that Treasuries will continue their uphill climb prompted the decision to raise the size, market participants said. The Municipal Market Data 10-year benchmark had risen to 2.55% Thursday from 2.44% a week ago.

CPS officials said the sale was moved up “due to favorable market conditions and our ability to meet our savings targets.”

“Today's successful bond sale, which will save CPS $30 million next year and reduce debt costs in all years, is yet another product of the historic funding reform” CPS chief executive officer Janice Jackson said in a statement. The deal forgoes the district's long-running scoop-and-toss habit -- in which the district issues new debt to pay maturing debt -- instead taking savings throughout the life of the bonds, though a chunk is front-loaded.

The sale’s results and strong interest “builds on the overall improvement in the district's finances, including the $455M reduction in short-term borrowing in FY18 compared to FY2017,” the district said.

With about $900 million in new recurring annual revenues won from the state over the last two years through new operating aid, pension assistance, and approval for increased property tax levies for pensions, the district has cut its spread penalties in half since last summer and trimmed short-term borrowing to $1.1 billion from $1.55 billion.

Market participants agree that the district’s fiscal gains helped, but structural protections on the bonds that include a state aid intercept, the insurance on many maturities, and hunger for yield were the primary drivers in the deal’s appeal.

Uninsured spreads ranged from 193 bp to 224 bp while insured tranches ranged from 120bp to 135 bp. The district had been trading at a range of 205 basis points to 235 bp, wrote MMD strategist Dan Berger.

“Perhaps there is a hunger for high yield paper. There has been more than $630mln in high-yield municipal bond fund inflows over the past two weeks according to Lipper,” Berger wrote.

The uninsured 10-year paid a yield of 4.78%, 224 basis points over the AAA, and the insured 10-year paid a yield of 3.87%, for a 133 bp spread. Both offered 5% coupons. The longest maturities in the refunding that went out to 2035 paid an uninsured yield of 4.95%, a 210 bp spread, while the insured 2035 paid 4.05%, a 120 bp spread. Both offered 5% coupons.

The shortest maturity in 2020 paid a yield of 3.82%, a 193 bp spread with a 4% coupon.

In November, the district's 10-year maturities landed at 4.55%, a 255 bp spread, and its 2034 bond, comparable to the long bond in Thursday’s sale, landed at 4.70%, a 225bp spread.

Both pricings illustrate how far the district has come since Gov. Bruce Rauner rattled the market in 2016 with comments calling the district a good candidate for Chapter 9 if the state added a bankruptcy statute to its books.

The district’s summer sale before the new state support was finalized saw spreads around 480 bp after hitting a high of 580 bp on a rate of 8.5% in 2016 after the governor’s comments.

The bonds were rated at an underlying B by S&P Global Ratings, BB-minus by Fitch Ratings and BBB by Kroll Bond Rating Agency.

The second half of a split maturity in 2022, the 2023 maturity and second halves of split maturities from 2025 through 2035 totaling $312.225 million carried the Assured-wrapped rating of AA from S&P and AA-plus from KBRA.

Fitch upgraded the district's rating last October. Kroll raised its outlook to positive in October. S&P boosted its outlook to positive from stable in April after raising it from negative last fall. The district has more than $7 billion of debt. Moody’s Investors Service was not asked to rate the bonds but rates prior issues at B3 and changed its outlook to stable from negative in September.

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