Chicago Public Schools brings its investment grade credit to market

Chicago Public Schools will tap its investment-grade dedicated capital improvement tax credit for the first time in five years in a $529 million issue pricing Tuesday.  

The Dedicated Capital Improvement Tax bonds, which offer several layers of protections that insulate pledged revenues from the school district’s operations, carry an A rating and stable outlook from Fitch Ratings and a BBB-plus rating and stable outlook from Kroll Bond Rating Agency. 

The Chicago district’s general obligation ratings have improved over the last few years, but three of its four ratings remain in junk territory.

A limited purpose dedicated property tax levy backs the CIT bonds.

“The portion of the levy not securing bonds has grown enough to support an issue of meaningful size related to our overall capital plans,” the school district said in a statement. “This along with the “A” rating from Fitch and “BBB+” rating from Kroll in the current rate environment made a compelling case to use the CIT credit at this time.”

While the CIT credit still faces steep spread penalties, CPS would see improved spreads compared to its 2018 deal if the paper prices in line with secondary market trading levels.

The 20-year bond in the previous sale landed at a 303 basis point spread to the Municipal Market Data’s AAA benchmark and is currently evaluated at 153 bps while the 30-year in the deal landed at a 304 bp spread and is currently evaluated at a 138 bp spread.

The district’s 25-year GO bond from its last sale in January 2022 is currently trading at a 190 bp spread after it originally saw a 121 bp spread at pricing.

Principal repayment on this week’s CIT deal is back-loaded with interest only being paid from 2018 to 2032. Principal amortization is scheduled to begin in 2033 but $328 million is in a 2048 term bond. Proceeds will finance school building projects including technology and science laboratories, ADA accessibility, overcrowding relief projects, and other improvements across the district.

BofA Securities and Loop Capital Markets are lead managers. Columbia Capital Municipal Advisors is advising and Katten Muchin Rosenman LLP is bond counsel.

CPS created the structure in 2016 to make investors comfortable that it could withstand bankruptcy as it struggled with mounting deficits that had dragged its GO ratings deep into junk territory. Then-Gov. Bruce Rauner had rattled investors labeling the district as a good candidate for bankruptcy, even though Illinois does not have a Chapter 9 statute on the books.

The ad valorem tax pledge is distinct from the district’s traditional double-barreled offering of a general obligation pledge and alternate revenue source pledge. It includes a direct intercept that sends the tax levy revenues directly from county tax collectors to the bond trustee.

Excess revenues are freed up after debt service payments in the current calendar year and through the following April are set aside and the district must identify and certify what projects are to be funded with the cash. The tax revenues are statutorily limited to pay for capital or for debt service on the capital levy backed bonds.

The General Assembly gave the city the ability to levy the tax in 2003 but it was not approved by the City Council until October 2015.

The bonds are further secured by a trustee-held debt service reserve. Fitch views the pledged revenues as meeting its criteria of “special revenues” that are protected in any bankruptcy proceedings allowing for a rating up to five notches above the CPS GO rating of BB-plus.

The Board of Education signed off on the CIT issue at its January meeting along with a potential GO transaction. CPS finance officials said they will evaluate the GO issuance after the CIT sale and have not set any timing.

Before the pandemic the district had made fiscal strides by reducing its reliance on short-term borrowing and rebuilding fund balances and reserves after a series of city and state fiscal measures that boosted levy and aid levels.

Federal pandemic relief has helped both fund social and educational investments while also making further fiscal progress, but some market participants worry about the district’s ability to maintain and achieve further gains.

In affirming the GO rating in December, Fitch said it views positively the district’s fifth consecutive general fund surplus in fiscal 2022. The district is lifting its once depleted fund balance to more than $1 billion.

Strains loom as the district exhausts federal COVID-19 relief. The 2022 budget relied on $633 million in federal stimulus spending and the $8 billion 2023 budget relies on $730 million with $607 million expected to be spent in 2024 and $200 million in 2025.

“The unwinding of federal stimulus as outlined by the district appears plausible but intensifying economic headwinds, political pressure and other factors could complicate decisions to scale back from stimulus supported social and emotional learning supports,” Fitch said.

Kroll caps its rating of the CIT bonds at the GO level.

“Our view on the overall credit profile of the board tempers our credit assessment of the CIT Bonds such that the Board’s general obligation credit becomes a limiting factor in the rating of the CIT Bonds,” the rating agency said.

The CIT rating “reflects the board’s improved financial position, which is underscored by a trend of enhanced State aid support, enactment of dedicated sources for pension funding, and most recently, ample federal stimulus funding,” Kroll said. “While the liquidity position has improved, it remains narrow as evidenced by the level of cash flow borrowing needed to support board operations at various points during the fiscal year.”

Kroll rates CPS GO bonds BBB and BBB-plus based on a legal opinion that pledged revenues are insulated from legal action.

Enrollment took another hit in fall 2022 falling by nearly 10,247 students to 322,106 but that was less than the prior year’s “pandemic-fueled decline of 14,500 students,” Fitch said.

Change also looms in CPS’ governance.

Gov. J.B. Pritzker signed legislation in 2021 moving to an elected school board over the objections of Mayor Lori Lightfoot, who warned of fiscal fallout.

In an investor slide presentation, CPS notes that the “elected school board changes CPS governance, not security for bondholders.”

A report the district published last year says the looming severance of governance ties between Chicago Public Schools and the city adds to strains to the district’s “fragile” fiscal health as federal COVID-19 pandemic relief is being exhausted and structural costs are mounting. Independent municipal financial advisor Columbia Capital Management assisted with the report, which delves into CPS finances and how Chicago and other city-related entities prop up the school district’s budget.

Even before accounting for any potential loss of city financial support, the district projects a return to red ink beginning in fiscal 2026, with a $628 million gap growing to $733 million in 2027 then falling to $650 million in fiscal 2028.

Change may be coming to the board before its members are elected; Chicago voters will decide from among Lightfoot and eight challengers in Tuesday’s election. No candidate is expected to capture a majority and the top two vote-getters will advance to an April runoff with the victor taking office in May.