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Wednesday, April 22, 2015 1:23 PM

The Chicago Penalty

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Chicago Pays Price to Get the Deal Done

Comparisons on the Bond Buyer in regards to Tuesday's offerings show Chicago Schools Pay Price to Get Deal Done.

The top yield of 5.63% on a 25-year maturity landed 285 basis points over the Municipal Market Data's triple-A benchmark.

While the board's rating remains in investment grade territory, its yields aren't.

Tuesday's MMD scale Tuesday put a mid-level, triple-B rated credit at a 3.78% yield on a 2039 maturity, underscoring just how severe a penalty the district paid. The Chicago Board of Education is rated between the BBB-minus level and A-minus.

Secondary trades on the board's $6 billion of debt jumped 140 basis points in recent weeks with 10-year paper trading around 250 basis points over MMD and 15 year paper trading at 300 basis points over.

The two tranches offered a C series for $275 million and an E series of $20 million in green bonds. Both carried a general obligation pledge plus an alternate revenue pledge of state aid.
The Penalty

Not only did Chicago have to pay a 285 basis point penalty over top rated bonds, it paid 185 basis points over similarly rated bonds even though the bonds contained an alternate pledge of state aid, and even though Illinois law does not "yet" allow bankruptcy.


Default risk.

Rauner pledged "The taxpayers of Illinois are not going to bail out the city of Chicago, that ain't happenin. But there are things we can do to help them restructure and get their government and their schools turned around, and I'd like to help them.".

Illinois taxpayers should commend Rauner for that stance.

Few Institutional Buyers

Here's a pair of telling comment from the article about who may be taking the risk:

"The 2035 is a discount structure, that typically signifies to me that you got some alternative buyers looking for some pop on the run, so they will try to trade on the headline news," said a Midwestern trader. "The structuring had a fairly deep discount. Only $10 million in the 2035, a little telling on the premium structure, which tells me you only have a few institutional buyers."

"The question that is on everyone's mind is did the Kroll rating do anything? Overall, it has wide spreads but you can really tell by the dollar amount who the buyers are," the Midwestern trader said.

Is this similar to the institutional shun and dump of GM bonds ahead of GM's bankruptcy?

Recall that high-yield GM bonds were dumped on unsophisticated mom and pop investors ahead of that debacle.

No Miracles Coming

I repeat what I said yesterday in Yield on Chicago School Bond Offering Hits 5.63%; Debate Over Risk; Miracles Not Coming; Bankruptcy the Sensible Option.

How is a state that has a $9 billion budget deficit hole going to bail out a single school district that is $1.1 billion in the hole?

The obvious answer is that it won't and can't. There are no miracles to be had. The Chicago Public School system is bankrupt. All it will take to trigger bankruptcy is for the legislature to allow just that.

That said, the law does mandate that parties in a chapter 9 bankruptcy dispute attempt to negotiate a settlement.

Realistically speaking however, history shows that unions will not concede benefits as they believe them to be sacrosanct, even though court decisions prove otherwise.

Detroit made a huge mistake time-wise attempting to forestall the inevitable. Rauner needs to give an out of court settlement a chance, but for the sake of Chicago and Illinois, that chance should be of limited duration.

Bankruptcy the Only Sensible Option

Since downstate voters will not want to bail out Chicago, we may easily be approaching the point the Illinois legislature realizes it has no choice other than to allow municipalities the option of declaring bankruptcy.

This won't come easily for the legislature, but it's the right thing to do. Upstate vs. downstate politics may be enough to tip the tide.

Mike "Mish" Shedlock

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