Chicago Borrows $160 Million for Schools as U.S. Aid Halts Teacher Firings

Wednesday, August 18, 2010

Chicago, whose credit rating was cut by two companies this month, is selling $164.1 million of municipal bonds for schools as its cost of borrowing has risen about 40 percent for taxable Build America securities.

The city plans to issue debt today to fund a $1.25 billion capital plan for the Chicago public school system. The district, with a $370 million budget deficit, faced having to fire 1,200 teachers until a federal jobs bill passed this month brought $105 million to maintain the workers, the Chicago Tribune reported.

The extra yield investors demand for Chicago’s Build America Bonds over 30-year U.S. Treasuries has widened 42 percent since a bond sale in January, according to data compiled by Bloomberg. The spread was about 223 basis points Aug. 16, up from 157 on Jan. 14. In the same period, the spread between a Wells Fargo Build America index and benchmark federal debt has widened about 24 percent to 199 basis points.

“There’s no doubt the market is penalizing them,” said Justin Hoogendoorn, a bond strategist at BMO Capital Markets in Chicago.

Chicago, the third most-populous U.S. city, has seen its tax revenue challenged by an unemployment rate of 10.6 percent, higher than the national average of 9.5 percent. Foreclosure filings in the first half for the Chicago area climbed 23 percent to 78,022, according to RealtyTrac Inc.

‘Serious Issues’

Chicago’s longer-maturity bonds may price at 280 basis points over Treasuries and 10-year securities at a spread of 100 basis points, said Richard Saperstein, managing director of Hightower Advisors LLC in Chicago. He said he isn’t buying.

“I’d rather have a bond that has the potential for an upgrade than one that would risk deterioration,” Saperstein said. “Chicago has some serious issues. They’re only going to get worse.”

The city, whose rating was cut by Fitch Ratings and Moody’s Investors Service because of shrinking reserves, is selling $143.4 million of taxable Build America Bonds and $20.7 million of tax-exempt debt through banks led by Samuel A. Ramirez & Co.

The U.S. government subsidizes 35 percent of the interest cost of Build America Bonds, which were authorized under the economic stimulus legislation passed by Congress and signed by President Barack Obama last year.

Higher Costs

Lower ratings may translate into higher borrowing costs as investors demand more yield in exchange for what they see as increased risk. The city’s last Build America sale, a $98.3 million issue in January, included 26-year bonds priced to yield 6.21 percent, or 3 basis points below the Wells Fargo index at the time. The securities traded Aug. 13 at an average yield of 5.94 percent, or 13 basis points above the index.

The Wells Fargo Build America Bond index has an average maturity of 28.83 years and an average credit rating of Aa3 and AA- from Moody’s and Standard & Poor’s, identical scores to Chicago’s.

Chicago, which doesn’t make predictions about borrowing costs during bond sales, has higher ratings than in 1979, said city spokesman Peter Scales, in an e-mailed statement. He acknowledged that Chicago has experienced “negative repercussions” from the state’s financial and budget problems, though he said they shouldn’t affect the bond sale.

“We do not believe the new ratings will have a significant impact on our borrowing costs,” Scales said in the statement.

Fitch lowered Chicago’s rating one step to AA, its third- highest, from AA+ because of the city’s accelerated use of reserves to balance its budget, the company said Aug. 5. Fitch maintained a negative outlook on the city’s $6.8 billion debt, meaning the rating might be lowered further.

Depleted Reserves

Moody’s Aug. 6 dropped the city to Aa3, its fourth-highest investment grade, from Aa2, also citing depleted reserves. Moody’s said 21.5 percent of the city’s $3.2 billion general- fund budget in 2010 largely came from reserves from the proceeds of leasing parking meters and the Chicago Skyway, an elevated highway that connects the city to Indiana.

In 2009, 16 percent of the city’s general fund came from those sources, said Ted Damutz, a Moody’s analyst. The city has about $935 million left in its reserves from the leases, down from $2.95 billion, he said.

“Chicago has been fortunate to have built up some cash reserves prior to the economic downturn to draw from,” said Richard Ciccarone, managing director of McDonnell Investment Management LLC in Oak Brook, Illinois, which owns $7 billion of municipal bonds, in an e-mail.

Chicago also is planning to sell $70.4 million of taxable notes the week of Aug. 23 to fund libraries.