Market scrutiny increases as Chicago teachers strike trudges on

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Illinois paper is looking more attractive when held up to Chicago city and Chicago Public Schools bonds as the district’s teachers strike moves deeper into its second week and concerns grow over the price tag for settling the rift, Citi’s municipal strategy group head said Tuesday.

“In order to resolve the strike the administration will have to make concessions that will come with higher costs so we are worried about the new revenues that will be needed to support the higher costs,” Vikram Rai said in an interview. “It’s hard to believe there will be no material impact on the credit if expenses are going up…and I am worried that as expenses go up CPS will be hard-pressed to find sources of revenues.”

CPS relies heavily on local property taxes and state aid. Tax levies fall under state caps and the latter aid is set by the state and Chicago is struggling with its own $800 million deficit.

While they are separate entities, the trading value of CPS and Chicago run in tandem as they are viewed “as being joined at the hip” due to their shared tax base, Rai said. Mayor Lori Lightfoot also handpicks district leaders and the board of education.

“We have always been bullish on Chicago. We like the credit. It’s a vibrant city and they have many levers to pull to correct” their fiscal problems but Citi is recommending to clients they might consider trading in their Chicago or CPS holdings for Illinois paper, Rai said.

CPS and Chicago are trading rich to Illinois at spreads of 125 basis points to 140 bps compared to the state general obligation at 150 bps to 160 bps. Citi views Illinois as a materially stronger credit given its more sweeping powers to manage its strained finances.

CPS carries three ratings in the single-B to double-B category and a fourth in investment grade territory while Chicago has one rating at one notch below an investment grade, two in triple-B territory, and one in single A territory. Illinois has two ratings at the lowest investment grade level and one at BBB.

Solving the strike that began last Thursday is no easy task given the various stakeholders. “There are no easy decisions. CPS teachers are fair in demanding fair wages. The mayor is right to worry about the costs being borne by the taxpayers, and the bondholders are justified in being worried about their investment,” Rai said.

As teachers and the school district remained at loggerheads over various contract demands on the length of a new pact, wages, working conditions, staffing, and class size, the board sold $250 million of tax anticipation notes Tuesday.

The rate on the unrated TANs that mature in March landed at 1.69% with JPMorgan submitting the winning bid, a roughly 55 basis point spread to the Municipal Market Data’s AAA 1-year bond.

The rate appeared on par with some past transactions and better than the most recent competitive TAN sale in June.

JPMorgan is the top provider of CBOE’s direct placement note issues and lead manager on many CBOE long-term deals in recent years. Several market participants said they expected the bank, and others, to step up on bids in a show of civic support for Lightfoot’s administration during the strike. Lightfoot's chief financial officer is also the former CPS CFO.

The last competitive sale of $250 million of notes in June that was divided into tranches paid interest rates of 2% and 2.125%. The notes matured in October and the spread was about 70 basis points more than the Municipal Market Data’s AAA 1-year bond.

In 2018, the district began selling some notes competitive in the aftermath of $1 billion in new state aid and pension funding and local property tax support that helped wipe out its deficit.

A $200 million issue that sold competitively in late 2018 with a March 2019 maturity landed at rates of 2.40% and 2.65%, a 55 to 80 bp spread. Another $200 million TAN that sold in late 2018 landed at 2.45%, about 55 basis points over the 1 year. The district used both direct purchases and competitive sales on its TANS.

The district paid punishing rates of 4.8% in prior fiscal years before its ratings stabilized and began inch up the speculative grade ladder.

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.

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Secondary bond market Primary bond market School bonds TRANs City of Chicago, IL Board of Education of the City of Chicago Illinois