More Chicago Schools Turmoil Ahead of Bond Sale

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CHICAGO - The head of Chicago Public Schools is temporarily stepping aside as federal authorities probe a $20.5 million no-bid contract awarded to her former employer, board of education president David Vitale announced Friday.

"In light of the ongoing federal investigation and its impact on her ability to effectively lead Chicago Public Schools, Barbara Byrd-Bennett is taking a leave of absence from Chicago Public Schools effective immediately," Vitale said in a statement.

The development comes just days ahead of the district's planned return to the bond market to sell $300 million of general obligation bonds that also carry a pledge of state aid. As of mid-day Friday, the deal being issued by the Chicago Board of Education was still on the calendar with a Tuesday sale date. PNC Capital Markets LLC is serving as the bookrunning senior manager.

Several market participants asked of the news said the leadership turmoil and negative headlines add to headwinds the deal is up against given its steep credit slide that triggered swap termination events, but investors may not see it as posing a fundamental credit risk.

Some investors will shun the sale over worries that CPS' credit could fall further hurting the bonds near-term value but it will lure those looking for yield, several market participants said.

CBOE 10-year paper has been trading at a 250 basis point spread to the Municipal Market Data's top rated benchmark while its 15-year paper has traded at a 300 basis point spread.

"Negative headlines and uncertainty typically has a negative effect, so the question is magnitude of that negative effect," said Michael Johnson, managing partner and head of research at Gurtin Fixed Income Management LLC.

"For a high yield investor, the CEO taking a leave of absence would likely have no effect on their interest, as most of the credit fundamentals remain the same," he added. "A typical high grade investor was likely on the fence anyway, and this situation probably presents just enough uncertainty to push them to avoid the new deal. " As a singular issue, the CEO's leave of absence might have little impact on the bonds' valuation as she has been viewed more as a leader hired to improve academic performance, said Richard Ciccarone, president of Merritt Research Services LLC.

When a credit "is under the microscope you don't like to see additional uncertainties come into play," Ciccarone said. He doesn't expect a significant impact on pricing from the latest news. City and board actions should be aimed at calming concerns that the district is distracted from solving its fiscal crisis, he added.

CBOE Vice President Jesse Ruiz will take over the CEO's duties. "As board vice president for almost four years, and a former chairman of the Illinois State Board of Education, Ruiz has both the legal and educational expertise and experience to guide the district at this time while ensuring students and teachers continue to make academic gains in the classroom," Vitale said.

Mayor Rahm Emanuel's administration decided on a leave of absence over seeking Byrd-Bennet's resignation as she hasn't officially been accused of any wrongdoing, sources said. Emanuel holds sway over most major school decisions as he appoints school board members and handpicks the CEO.

The contract under question went to SUPES Academy which trains principals. Byrd-Bennett worked there before taking an advisory position with CPS in 2012. She was elevated to CEO later that year after Jean-Claude Brizard was forced out following a teachers' strike. Her contract expires in June.

The disclosure of the federal probe only became public on Wednesday when the district issued a statement acknowledging an investigation with few other details. The company later acknowledged the probe.

The leadership turmoil comes at a critical juncture for the district. It faces a $1.1 billion deficit in its fiscal 2016 budget beginning July 1, due in large part to a $700 million pension payment. Its grappling with a $9.5 billion unfunded pension obligation tab and annually bumps up against its property tax cap. The district also is embarking on teacher contract negotiations.

Emanuel and CPS officials are pressing for state legislative support that would ease the CPS pension burden, arguing that local taxpayers are penalized by having to pay property taxes toward Chicago teachers' pensions and income taxes that support the state teachers' fund.

On Tuesday, Gov. Bruce Rauner, who is pushing to add a Chapter 9 provision to state statutes, suggested bankruptcy was an option for the insolvent district and warned that no state "bailout" would be coming.

City and CPS officials have rejected the idea of a bankruptcy option and noted that legislation sponsored by a Republican lawmakers allowing for Chapter 9 hasn't gained much traction in the Democratic controlled General Assembly.

The headlines "hurt valuation" and "impact reception," although the bottom line for "savvy investors is the fundamental credit quality," Robert Miller, senior portfolio manager for Wells Capital Management said earlier in the week.

After selling floating rate notes, the board late last month pushed off the second piece of its financing — about $300 million of new money bonds — to April 21 to let the market digest a round of multi-notch downgrades that triggered swap termination events. The district also was concerned that market jitters over the April 7 mayoral run-off could hurt the sale.

The CBOE completed the sale of two floating note tranches, each for about $89 million, to refund variable-rate paper on March 24, paying a steep penalty for its credit woes in a rate of 4.02%.

Moody's on March 6 downgraded the board's $6 billion of GOs two levels to Baa3 and assigned a negative outlook. Ahead of the new sale, the board did not seek a rating from Moody's. It sought fresh reviews from Fitch Ratings and Standard & Poor's and a new rating from Kroll Bond Rating Agency.

Fitch last month lowered the district's GOs to BBB-minus from A-minus, assigning a negative outlook. Standard & Poor's lowered the district's rating by two notches to A-minus and assigned a negative outlook. Kroll assigned a first-time rating of BBB-plus with a stable outlook.

A termination event on its swaps was triggered when both Moody's Investors Service and Fitch Ratings lowered the district's GO bonds below the BBB level. The district's 10 interest rate swaps on a notional amount of $1.1 billion of paper carry a current negative valuation of $228 million. CPS is negotiating with the counterparties to stave off payments, but has not responded to requests for an update on the negotiations.

The board released an addendum to its offering statement Friday disclosing the investigation and leadership changes.

The board received federal grand jury subpoenas dated April 14 seeking records related to an "official criminal investigation relating to past and current board contracts" with SUPES, Synesi Associates, and Proact Search. They seek records including personnel files and employment records of four board members, including Byrd-Bennett.

"The board will respond to these subpoenas," the addendum reads. "The board cannot predict the outcome of this investigation and the board believes that this investigation will not materially impact its finances or its ability to timely pay debt service or on the security" for the bonds.

The Emanuel administration said it supported the leadership shift which Byrd-Bennett agreed to. "Though there have been no formal allegations, the mayor has zero tolerance for any type of misconduct from public officials and welcomes today's decision to help ensure this issue does not distract from the incredibly important work happening in our neighborhood public schools," said Emanuel spokeswoman Kelley Quinn.

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