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Tuesday, April 21, 2015 1:25 PM

Yield on Chicago School Bond Offering Hits 5.63%; Debate Over Risk; Miracles Not Coming; Bankruptcy the Sensible Option

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Today a $295.7 million bond offering by the beleaguered Chicago Board of Education hit the market.

The Yield Hit 5.63%. That is 285 basis points higher than Municipal Market Data's benchmark triple-A scale.

Debate Over Risk

Municipal Market Analytics (MMA) says Despite it All, Chicago Schools' Default Risk is Low.

Peel away the layers of negative headlines and patient investors will find low default risks and underlying credit strength in this week’s $300 million Chicago Board of Education deal, according to Municipal Market Analytics.

“BOE debt is well insulated from default risk by significant 'belt and suspenders' protections,” MMA wrote in a market piece authored by Matt Posner & Kevin McGuigan Friday. “We understand that negative headlines, downgrades and Chapter 9 speculation have all damaged value but believe the case can be made for a considerable underlying credit strength that exists for patient investors.”

The bonds’ value has been hurt by a stinging series of negative headlines, from multi-notch bond rating downgrades to Gov. Bruce Rauner’s comments that no state bailout looms and bankruptcy is an option.

“Regardless of statements by the governor, Chapter 9 is likely a low probability outcome, allowing for a less cynical reading of CPS’ otherwise strong pledged security,” MMA wrote Monday in its weekly outlook authored by Matt Fabian, Lisa Washburn, and Bob Donahue.

“This security presents only minimal payment default risk,” Monday’s outlook piece said.
Debate Over Risk

I strongly disagree the MMA's assessment. While it's true that municipal bankruptcies are rare, the odds of this deal working out well are poor.

The only saving grace at the moment is that Illinois does not allow municipal bankruptcies.

And 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.".

Simple Facts

  • The Chicago Public School System has a $1.1 billion budget bole in a $5.9 billion budget
  • The 2015 budget kited two months of property taxes from the fiscal 2016 budget
  • A $228 to $263 million derivative time bomb just triggered on the Chicago Board of Education
  • Chicago Public Schools may be out of cash in 30 days
  • Corruption investigations plague the school board
  • The school district faces a pension payment in 2016 of about $700 million.

No State Rescue

Where is the school district going to get $1.1 billion? Where is it going to get a $700 million pension payment?

The state? Think again.

Illinois Budget Deficit is $9 billion

Don't expect the state of Illinois to come to the rescue!

Crain's Chicago Business says Illinois' Budget Deficit is Twice as Bad as You Think.
Illinois' fiscal woes are significantly deeper and more serious than generally realized, with the state facing a $9 billion operating deficit in the fiscal year that begins July 1.

That's the horrific bottom line of a report released late today by researchers at the University of Illinois Institute of Government and Public Affairs, a study that may raise the eyebrows even of Gov. Bruce Rauner, who has been warning of huge financial problems ahead.

The conclusion: The actual deficit is about twice what is commonly reported, with the hole in the current fiscal 2015 budget not $2 billion to $3 billion but $6 billion, and rising to a projected $9 billion in fiscal 2016 and hitting $14 billion by fiscal 2026, assuming no changes in law or spending practices.
No Miracles Coming

How is a state that is $9 billion in the 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.

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.

Right Idea

Rauner has the right idea on taxes, on bankruptcy, and on a bailout of Chicago.

Not a penny of taxpayer money should go to fund a lost cause. I find it hard to believe that Emanuel himself does not know the school system is truly bankrupt.

When you are bankrupt, the only sensible thing to do is admit it.

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

For more details on the miserable state of affairs of the Chicago Public School System, please see Credit Swap Event Triggers for Chicago Schools: Out of Cash in 30 Days, Cooking the Books to Oblivion.

Mike "Mish" Shedlock

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