Chicago Public Schools heads into the market this week on a ratings upswing but headline risk remains amplified after teachers refused to report to classrooms for most of a week amid a new COVID-19 surge.
The junk-rated Chicago Board of Education will raise $500 million of new money in one series to cover capital spending over the next 12 to 18 months, and a second series for $363 million will refund 2011 bonds for present value savings. The district won’t extend or restructure debt service in the sale scheduled for Thursday.
The district’s positive fiscal trajectory, buoyed by federal coronavirus relief, and demand for yield should help draw interest but national headlines also loom large following a dispute between the Chicago Teachers' Union and the district and Mayor Lori Lightfoot about in-person learning.
Spreads to triple-A benchmarks in a pre-marketing pricing wire distributed by senior manager Goldman Sachs early Tuesday ranged from 115 to 120 basis points with a 4% coupon. That's wide to where CPS bonds with a 5% coupon have been trading in the 70 to 80 bp range so the paper should find widespread appeal for investors searching for yield and 4% so spreads likely will narrow, market participants said.
"They are going to be cheap in the pre-marketing because it's in a discovery phase. So you come out weaker and see what nibbles you get and measure interest and build the book," said one market source. The 4% coupon adds between 10 and 15 bps to spread depending on the maturity.
Classes will resume Wednesday after the union agreed to suspend its work action that had forced CPS to close schools over the last week as the district refused to meet the union’s demands that schools move to remote learning in the absence of a deal on safety measures.
The resulting national headlines underscoring the district's long-running labor conflicts may create some tailwinds for the pricing but resolution of the matter also helps.
Spreads at 115 to 120 bps would make the paper "very attractive, particularly compared to state GOs. The bond security, including both state aid and a GO pledge, is strong and we see the board’s finances as improved since the state’s school funding law changed in 2017,” John Ceffalio, senior municipal research analyst at CreditSights, said Tuesday. “We do not see a long-term impact from the recent shutdown on the board’s long-term credit."
Students had returned from the holiday break Jan. 3 amid surging COVID-19 cases as the omicron variant spread but the following evening rank-and-file teachers voted to move to remote learning in the absence of an agreement on working conditions that included testing requirements and triggers for school closures.
Lightfoot and district officials attacked the move as an illegal work action that violates the teachers’ contract and statutes. CPS canceled classes and locked teachers out of the remote system while negotiations continued.
“We are hopeful that investors will see the long-term benefit of investing in the CPS credit based on the good work we have done financially in recent years. These are challenging times for many school districts around the country, but we know the current challenges are transitory,” CPS said in a statement last Friday before the standoff was resolved as the board stuck with a planned Thursday pricing.
“They have the benefit that investors are still groping for yield so they will do pretty well,” said Howard Cure, director of municipal bond research at Evercore Wealth Management LLC.
“The CTU vote and reopening actions will not have a material adverse effect on the ability of the board to provide for the punctual repayment of the bonds by the deposit and application of pledged state aid revenues and, if needed, pledged taxes,” the bond offering statement says.
The new money debt matures from 2042 to 2047 and the refunding matures through 2041. Both are tax-exempt and fixed-rate with state revenue serving as a backup pledge to the district’s full faith and credit.
Siebert Williams Shank is joint senior underwriter with Columbia Capital Management as advisor.
The pre-marketing wire seeks "feedback" on the scale ahead of the Thursday pricing. In the new money, the 2042 offers a 2.68% yield and the 2043 offers a 2.71% yield and the 2047 a 2.80% yield. All are at a 120 bp spread. The refunding bonds offer a 2035 maturity at 2.44% for a 115 bp spread, a 2036 maturity at 2.48% for a 118 bp spread with the remaining maturities at a 120 bp spread and yields of 2.53% to 2.65%, according to the wire.
The 10-year bond in the district’s January 2021 sale landed at a spread that marked a low in recent memory at 123 basis points to the Municipal Market Data’s AAA benchmark and it’s more recently been evaluated at a 78 bp spread.
The district's spreads have sharply narrowed from a bruising 480 basis points on its long bonds in 2017 that followed a peak spread of
The district’s October 2019 sale saw the 10-year land at a 140 bp spread and has been trading at a 68 bp spread. The district’s December 2018 deal’s 10-year was insured but the nine-year bond landed at a 217 bp spread and has been evaluated at a 71 bp spread.
The district might also benefit from the state government’s
Ratings
Ahead of the issue, Fitch Ratings upgraded the district one notch to BB-plus, leaving it only one notch below investment grade.
The agency cited new state and city support in recent years and a flood of federal relief bolstered the balance sheet and cushioned the pandemic’s impact. Fitch also upgraded the district’s separate credit known as the Capital Improvement Tax levy or CIT to A from A-minus.
Kroll Bond Rating Agency, the sole rating agency that has CPS GOs at investment grade, raised the ratings one notch to BBB-plus for bonds with a legal opinion on the insulation of special pledged revenues and to BBB for those without the opinion like the upcoming sale.
S&P Global Ratings affirmed the district’s BB ratings and stable outlook and Moody’s Investors Service was not asked for a rating.
“Our cash and liquidity improved in fiscal year 2021 and into the beginning of FY 2022, but the genesis of this goes back further to changes in the state of Illinois school funding formula and our dedicated pension property tax levy,” the district said in a statement. “The allocations of federal stimulus aid have also helped improve our cash and liquidity on top of these recent state funding changes.”
CPS is received a total of $1 billion from the first two federal relief packages and another $1.8 billion from the American Rescue Plan Act signed last March. The $9.3 billion fiscal 2022 budget relies on about $1 billion of relief that should support budgets through 2024. The district spent $206 million in fiscal 2020 and $339 million in fiscal 2021 leaving about $1.2 billion for the next two fiscal years.
“You really want to see some fiscal discipline on how they are using this federal money,” Cure said.
While the GO pledge provides the ultimate backstop, the bonds also benefit from an alternate revenue pledge of state aid that benefits from a post default remedy provision that sets aside aid needed for debt service and is only freed up for the district as long as it doesn’t default on the bonds or file bankruptcy, which Illinois law does not currently allow local governments to file.
The district’s operating fund balance has grown to $804 million in fiscal 2021 from $567 million in 2020 and a negative $275 million in 2017 and it’s trimmed its annual cash flow borrowing by a total of $600 million over the last four years. The district has $8.8 billion of debt.
While near-term fiscal stability has driven upgrades, rating agencies warn of long term strains.
Annual state increases of about $350 million for public schools remains dependent on the state’s fortunes, the district remains weighed down by a $15.4 billion pension burden and 42% funded ratio, negative cash flow still requires cash flow borrowing, and there’s concern about the district's fiscal management after it moves to an elected board under legislation passed last year. The district, now led by mayoral appointees, will be run by a partially elected board in 2025 and a fully elected school board by 2027.
“I don't know what to expect as to how conscious an elected board will be of the budget,” Cure said questioning what influence the union might have. “It’s a big question mark.”
Kroll said the upgrade reflects the district’s “strengthened financial position” but it will be watching for any “absence of adherence to fiscal discipline and adoption of credit negative policies by future elected school boards.”
Rating agencies view the fractured union relationship as a negative and it could set back efforts to return to investment grade.
“A higher rating is predicated on the successful navigation of the COVID-19 pandemic, which includes keeping schools open and managing a persistent, combative union relationship,” S&P said.
“A contentious relationship with the Chicago Teacher's Union places additional strain on the district's expense management and flexibility,” Fitch said.
The district is the third largest in the country with an enrollment of 340,658. Enrollment was down nearly 14,500 students in fiscal 2021 following a loss of more than 6,000 students the prior year.
Several community groups and Alderman Rossana Rodriguez dragged city finances into the union dispute Monday accusing the city of steering a portion of its federal relief to pay off a $450 million credit line with JPMorgan in violation of U.S. Treasury guidance that bans use of the ARPA aid to repay debt and calling on the federal government to investigate and claw the funds back.
Saqib Bhatti with the Action Center on Race and the Economy said at a news conference Monday announced by the Chicago Teachers’ Union: “The money we need to safely reopen schools Mayor Lightfoot gave it away to Chase Bank and other Wall Street firms. We need to get it back."
Chicago initially hoped to repay the credit line — taken out to put off scoop and toss debt restructuring to buy more time for a federal relief package to pass — with expected aid but the guidance barring such use prompted the city to shift gears. Instead, the city used available tax revenues to repay the loan as federal guidance did allow the city to cover previous pandemic related revenues losses with relief leaving other revenues available.
"This is patently false. Our financial team has been extremely conscious to ensure that we followed the Treasury guidelines. ARP funding is and will be used only for eligible costs as outlined in the guidance issued by the U.S. Treasury,” a mayoral spokesperson said in a statement.
