Brian Battle, director of trading at Performance Trust Capital Partners
“I think the market voted ‘yes’ on the structure,” said Brian Battle,

CHICAGO – Lured by opinions and ratings endorsing a bankruptcy-remote deal structure and a still-steep yield penalty, investors snapped up Chicago Public Schools' A-rated capital improvement tax bonds.

The Chicago Board of Education deal – led by Barclays and JPMorgan with Barclays running the books – was raised to $730 million from $500 million in the preliminary pricing circulated Thursday, indicating its strong reception. The district has board-approved authority to sell up to $840 million under the credit.

The bonds are secured by revenues generated from the capital improvement tax property tax levy approved by the City Council last year.

The revenues flow directly to the bond trustee, are earmarked solely for capital projects or to repay the CIT-backed bonds, and are restricted from general revenues – factors that Fitch Ratings cited to assign the deal an A rating, eight notches above its junk-level rating for CPS general obligation bonds, saying the rating reflects bondholder protections should the district ever land in Chapter 9.

The high yield in the deal Thursday landed at 6.25% with spreads sharply tighter from the high 8.5% yield on CPS' last general obligation sale in February, which raised questions about the district's future market access because state law caps interest at 9%.

What the results Thursday showed is that "the Chicago Board of Education has market access with this structure at this price," said Brian Battle, director of trading at Performance Trust Capital Partners.

Battle said the size boost showed just how strong demand was at anticipated pricing levels and the legal opinions and A rating gave investors enough comfort to overlook the district's precarious liquidity, structural budget woes, and reliance on uncertain state aid.

"I think the market voted 'yes' on the structure," Battle said, adding that the wide spreads highlight "an injured credit" that reflects the city, board of education, and state's damaged names.

With demand in hand, the board was wise to raise the size of the deal given the Federal Open Market Committee's comments Wednesday that multiple rate hikes should be expected next year, he said.

"You want to sell as many bonds as you can now," Battle said.

The bulk of the deal -- $577 million – came in a 2046 maturity that paid a yield of 6.25% with a coupon for 6% and price of $96.649.

The remainder sold in terms due in 2033, with a 5.95% yield and 5.75% coupon; a 2034 term with a 6% yield and 5.75% coupon; a 2035 term with a 6.05% yield and 5.75% coupon; and a 2036 term with a 6.10% yield and coupon.

The coupon structure and large, long maturity bolsters liquidity, market participants said.

The 2046 yield landed 309 basis points over the Municipal Market Data's top-rated benchmark of 3.16% on a comparable maturity, which reflects a 5% coupon structure. It's also 243 basis points over the single A benchmark of 3.82% on a comparable maturity and 207 basis points over the BBB benchmark of 4.18%.

That's down sharply from the 580 basis point spread the district paid on its last general obligation sale in February. Its 10-year GO has been trading at 450 basis points over MMD while the city has been trading at 350 bp. The district paid 7.25% on a GO private placement over the summer.

"CPS successfully sold today $729 million of A-rated Capital Improvement Tax bonds with proceeds from these dedicated capital bonds going towards much-needed capital investments like relieving overcrowding, modernizing schools and making critical repairs," said Ronald DeNard, senior vice president for finance at CPS, in a statement. About 45 investors participated in the transaction.

The isolation of the funds for capital is the cornerstone of a structure that secured legal opinions from the deal's bond counsel and underwriters' counsel saying tax collections would meet the U.S. bankruptcy code's definition of special revenues.

Such a designation would allow for their continued flow to debt repayment in the event of a Chapter 9 filing and offers strong protection from a haircut in a confirmation plan.

Kroll Bond Rating Agency assigned its BBB rating and a negative outlook. The Kroll rating was on par with its rating on the district's last GO issue in February. It recognized the special revenue argument but also took into account the district's precarious liquidity and structural budget woes.

The district did not ask Moody's Investors Service or S&P Global Ratings to review the new credit. They both join Fitch in keeping the district's GOs in junk territory.

The state does not have a general municipal bankruptcy statute, but Gov. Bruce Rauner would like one and has said CPS would be a bankruptcy candidate. His comments rattled investors ahead of a CPS GO bond deal this year.

The sale followed investor calls held by CPS and its finance team with investors over the last week after the release late last week of the Fitch and Kroll rating reports. The district also posted a supplement to its offering statement Tuesday adding language to strengthen perceived bondholder protections.

The structure and CPS' position of the insulation of pledged from Chapter 9 came with warnings that the structure was not without risk on multiple fronts. Even if a bankruptcy court agrees that the tax revenues met the special revenue designation and enjoy a statutory lien allowing debt payment to bypass the automatic stay, with no existing case law in place there's no assurance some form of impairment can't occur under a restructuring plan the court finds "fair and equitable."

"The main trouble with the transaction lies not with the documents but with the assumption— generally implicit yet quite explicit in the opinions—that the fiscally distressed district will unconditionally continue to abide by, and not challenge the provisions of, the indentures or 'use or claim the right to use' the capital improvement tax revenues," Municipal Market Analytics said earlier this week in an outlook piece.

"Investors in the district's new capital improvement tax bonds should seriously consider the bondholder settlements in Detroit (not to mention the ongoing legal battles in Puerto Rico) when deciding what interest rate is sufficient compensation for the legal and credit uncertainties present in this transaction," MMA wrote.

One of a handful of language additions in the supplement posted on Tuesday appeared aimed at addressing that concern.

"The board will not seek or support state legislation which, if enacted into law, could reasonably be expected to materially impair the security for the payment of the bonds or the board's authority to pay the bonds from the trust estate," said an addition to the "Security for the 2016 Bonds" section of the offering statement.

The legal opinions and bond rating reports all noted continued risks in spite of the structure's bankruptcy-remote strengths.

"Based on consultation with external counsel, it is KBRA's understanding that the Capital Improvement Taxes levied under the CIT Act would likely be treated as special revenues in a Chapter 9 bankruptcy proceeding. Nevertheless, there is no applicable case law upon which to make a definitive judgment as to whether these pledged revenues would in fact be determined to be special revenues, which tempers KBRA's credit assessment," Kroll wrote.

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