Who’d have thought the financially strapped Chicago Public Schools could get an A-rated bond today.
It happened Thursday.
Fitch gave a proposed bond issue an A rating with a stable outlook — that’s eight steps above the junk rating of B-plus with a negative outlook that the ratings agency has assigned to the $6.8 billion in CPS’ general obligation debt. The Kroll Bond Rating Agency Inc. also rated the bonds at BBB, deeming them of “medium quality.”
CPS accomplished the feat in two ways: First by proposing the sale of a half-billion dollars in capital bonds tied to a special property tax, and second, by raising the specter of a “hypothetical bankruptcy” in its bond offering to assuage investor fears about the cash-strapped district’s financial risk.
Last February, CPS had to pay a whole lot more to borrow less than planned after after Gov. Bruce Rauner raised the possibility of forcing the state’s largest district into bankruptcy.
State law doesn’t permit school districts to declare bankruptcy nor is that likely to change anytime soon so long as the General Assembly remains in Democratic hands. But borrowing costs jumped right after the governor’s mention of the b-word.
CPS is now preparing to sell $500 million in bonds toward nearly a billion’s worth of capital improvements, and keep its costs of borrowing as low as possible. Officials plan to speak with potential investors next week.
A preliminary prospectus released this week contends that those investors have nothing to fear. That’s because the bevy of up to $938 million new school construction projects — including several brand new schools — will be financed by a $45 million property tax increase approved by the City Council last year for the sole purpose of school construction.
It is, therefore, insulated from the larger financial crisis caused by Rauner’s surprise veto of a bill that would have provided $215 million in state pension help to CPS.
If the governor’s veto is not overturned, CPS could have no choice but to cut deeply into classrooms that already have been assaulted in recent years by multiple rounds of cuts.
In a recorded investor presentation attached to the bond documents, Ronald DeNard, senior vice president of finance for CPS, portrayed the capital improvement tax as providing “unique credit and security.”
“The credit is secured by a new, unencumbered, limited purpose, dedicated property tax levy within the school district that will be statutorily limited to capital improvement. [It] cannot be used for operating expenses,” DeNard said.
“The CIT aren’t general revenue nor are they available for debt service on any of the board’s existing debt.”
To further reassure skittish investors, CPS attached to the prospectus a pair of legal opinions on a “hypothetical bankruptcy” by the state’s largest school system.
Bond counsel Katten Muchin Rosenman LLP and underwriters’ counsel McDermott Will & Emery LLP both say that the property tax levy for capital improvements would qualify as “special revenues” isolated from general operations under the U.S. Bankruptcy code.
That means there would be no risk to investors, even in the event of a CPS bankruptcy. The bonds would be exempt from a typical automatic stay on debt held by an entity filing for bankruptcy protections.
Investors would be further protected by a “direct intercept” structure that means CPS never touches the money from the special property tax. A provided flowchart shows the tax money going from taxpayers to county collectors to a third-party trustee. The debt-service fund is at the top of the payment list.
“CIT revenues flow directly from a third-party intercept structure isolating the CIT credit from the board’s general credit,” the documents state.
CPS Chief Financial Officer Jennie Huang Bennett also reassured potential bondholders that “the base CIT levy amount never decreases.”
“The specific levy of the CIT payment of the 2016 bonds and strict isolation of revenues for dedicated capital improvement projects means that the 2016 bonds as structured would be considered secured by special revenues and would be paid timely in a hypothetical Chapter 9 proceeding and not subject to the automatic stay provisions of the U.S. Bankruptcy code,” Bennett said.
CPS, which may have to make more major changes to its budget next month if Springfield doesn’t come through, points out that the capital spending money can’t be used for everyday operations. The district proposes to build a series of annexes to relieve overcrowding. It has hatched plans for new schools, too, including a brand new high school on the South Side.
District officials did not immediately respond to requests for comment.
“Because bondholders will be paid out of the special levy, they would (in theory at least) continue to be paid during a district bankruptcy,” Matt Fabian, a partner at Municipal Market Analytics, said in an email. “In the case of CPS, where the problems are all on the expenditure side and not the revenue side, a cleaner connection between the levy and bondholders will be attractive for at least some investors. Meaning a lower interest rate.
“The problem is that there is no silver bullet,” he continued. “CPS still faces massive headline risk, an untenable budget situation, and a governor who appears to want to make things more difficult not less. That equates to major negative momentum.”
Earlier this year, Mayor Rahm Emanuel charged that CPS was forced to pay more to borrow less because of Rauner’s continued talk of bankruptcy — and if that was the governor’s intention, it was “shameful.”
“The governor is well-versed in finance, coming out of private equity and the financial world. His comments weren’t helpful. . . . It affected certain things. . . . If it was intentional, it’s shameful. Only he can answer whether that was the purpose,” Emanuel said, two days after CPS was forced to pay an 8.5 percent interest rate.
One week after abruptly halting a bond sale needed to keep the school doors open through the end of the school year, CPS returned to Wall Street — but paid a huge price for the delay.
Instead of borrowing $875 million, the bond issue was scaled back to $725 million. And instead of paying the 7.75 percent interest rate offered on the tax-exempt bonds, CPS had to promise buyers a higher yield of 8.5 percent.
It followed a tumultuous week that saw the Chicago Teachers Union reject a new four-year contract because it doesn’t trust CPS while Rauner, who shares the union’s view, said the state was getting ready to take over Chicago Public Schools.
The governor branded the borrowing “tragic” and accused his old friend Emanuel of “kicking the can” and costing taxpayers “more in the long run.” Rauner contended there were only two alternatives for CPS: bankruptcy or “massive” tax increases.
The mayor fired back.
“The state under his leadership . . . is now up to $7 billion in unpaid bills and growing. That’s not exactly who you would turn to for financial stewardship and leadership,” Emanuel said of the governor’s threat to take over Chicago Public Schools.
Emanuel defended the costly borrowing — and the $100 million in budget cuts that helped reassure skittish investors — as essential to keeping the school doors open until the state school aid formula can be rewritten, as state Senate President John Cullerton, D-Chicago, has promised to do with Rauner’s help.
“Given the option of cutting teachers in the classroom, therefore increasing class size, or [borrowing to] get us enough time so we can work with the state to be a partner with Chicago on a solution, [borrowing] was the option chosen because I believe the kids and the teachers in the classroom should not pay a price for the . . . disparity in the system where our students are at a different level financially from the state. They literally receive less money and less support when you put all of the resources together,” Emanuel said.