Verge of a Bond Market Shutoff
The Chicago Board of Education is on the verge of a bond market shutoff.
On January 27, the CBOE Canceled an $875 Million Bond Offering due to hostile conditions. At that time, I commented “Will the yields be any lower tomorrow? Next week? Why?”
Today, we have the answer: Chicago Public Schools Gets Sale Done at Big Penalty.
Battered by negative headlines about its solvency, labor troubles, and a state takeover threat, the Chicago Board of Education returned to the market Wednesday after a one-week delay to price a scaled-down deal that offered a hefty high yield of 8.50%.
The district initially planned last week to offer $875 million of general obligation paper, including $795 million in a tax-exempt tranche and $80 million of taxable securities.
The final offering run by JPMorgan was sized at $725 million and came entirely as tax-exempt. CPS [Chicago Public Schools] appeared to have dropped the taxable piece while the yield on the deal’s long bond shot up by 75 basis points over what CPS had been aiming for last week.
“The numbers suggest they are on the brink of losing market access,” said Richard Ciccarone, president of Merritt Research Services. “The numbers suggest there is a lot of doubt about whether CPS can find a method and means to solve its financial problems. Can this be a catalyst to bring together what looks like a polarized political situation?”
More Unsavory Details
- The 8.50% yield on the 28-year bond landed 580 basis points over the Municipal Market Data’s top-rated benchmark for a similar maturity and nearly 500 basis points over a BBB credit.
- The yield on the 10-year maturity landed 607 basis points over a similar top-rate maturity and 515 basis points over a BBB credit.
- Fitch Ratings, Standard & Poor’s, and Moody’s Investors Service have the district deep in speculative-grade territory with single-B level ratings.
- The deal received a BBB rating from Kroll Bond Rating Agency.
- The preliminary price on the taxable, 17-year maturity, completely axed from this week’s deal, offered a yield of 9.75% with a coupon of 9.50%.
- About $393 million was to reimburse the district for money already spent.
Rate Shopping Whores
Please note the ludicrous BBB rating by the Kroll Bond Rating Agency.
That rating is a signal that Kroll wants all the business it can get and is willing to provide nonsensical ratings to get that business. This is precisely what happened with ratings in the housing crash.
For more details please see Rate Shopping Whores and Chicago’s Bond Rating.
Origin of Rate Shopping
Originally, it did not work like this. And I have been harping about the underlying problem for years. A good starting point is my September 28, 2007 post Time To Break Up The Credit Rating Cartel.
Here is a recap.
The rating agencies were originally research firms. They were paid by those looking to buy bonds or make loans to a company. If a rating company did poorly it lost business. If it did poorly too often it went out of business.
Low and behold the SEC came along in 1975 and ruined a perfectly viable business construct by mandating that debt be rated by a Nationally Recognized Statistical Rating Organization (NRSRO). It originally named seven such rating companies but the number fluctuated between 5 and 7 over the years.
Establishment of the NRSRO did three things (all bad):
- It made it extremely difficult to become “nationally recognized” as a rating agency when all debt had to be rated by someone who was already nationally recognized.
- In effect it created a nice monopoly for those in the designated group.
- It turned upside down the model of who had to pay. Previously debt buyers would go to the ratings companies to know what they were buying. The new model was issuers of debt had to pay to get it rated or they couldn’t sell it. Of course this led to shopping around to see who would give the debt the highest rating.
Instead of rating agencies getting paid on the basis of how well they rated debt, the rating agencies got paid on how favorably they rated debt!
On May 18, 2015 I put together a table of how various rating agencies rate Chicago debt. This is what it looked like at the time.
| Rating Agency | Date | Rating | Level | Outlook |
|---|---|---|---|---|
| S&P | 5/14/2015 | A- | 3 Levels Above Junk | Negative |
| Kroll | 5/11/2015 | A- | 3 Levels Above Junk | Stable |
| Fitch | 5/15/2015 | BBB+ | 3 Levels Above Junk | Negative |
| Moody’s | 5/12/2015 | Ba1 | Junk | Negative |
| Egan-Jones | 5/18/2015 | “Deep Into Junk” | Negative |
Egan-Jones ratings from phone conversation with Sean Egan.
How To Gain Market Share
Gaining market share is easy. All you have to do is give a higher rating than anyone else.
Regardless of what rating anyone assigns Chicago debt, the Chicago public school system is in deep, deep trouble. Bankruptcy is the only sensible solution.
Mike “Mish” Shedlock
Chi-town did not go bankrupt overnight, it has been going down that road for decades. Anyone who could do simple math could see it coming, but the pols and the beneficiaries preferred to just ignore it. Now those old corrupt politicians are gone and the new pols today have to figure out how they are going to deal with it. Since they cannot face reality (the unions that run Chicago forbid it), they have to rely on fantasies. Good luck, chumps. 2 minus 4 is still negative; math is math.
It doesn’t matter what rating is given once the market shuts-off for these offerings. The important thing is what happens with the overhang since at that point raising taxes 10-20x won’t fix the problem since they simply won’t be paid anymore and the only plausible outcome is massive layoffs for the budget consuming officialdom.
Thus far very few cities had a gulp moment where they were left completely hanging and needed to gut their staff, as their tax base imploded over decades. Here we may see what can be achieved at greater speed, perhaps in a few years.
“That rating is a signal that Kroll wants all the business it can get and is willing to provide nonsensical ratings to get that business. This is precisely what happened with ratings in the housing crash.”
Yup! Exactly the same.
Welcome Fedwatcher!
Of the $725 million I’m guessing JPMorgan gets $300 million and Chicago Schools get $425 million.
? Who’s going to buy the bonds knowing the city school system is trending water. Even those that need to protect principle have better options.
The Underwriters know the strip coupons buyers will stick it to the end purchasers that need a loss. So we are in a recession that relies on negative rates.
I never would of believed I would live to the day where profit is made by subtracting from something.
Welcome to WordPress Mish .
? Who’s buying bonds from a school system trending water
the underwriters know the answer the money is in the stripped coupons
Need a loss buy this Junk
never thought I would live to the day when profit is made by selling a negative
But who’s going to risk getting left hold the bag when the CSS declares bankruptcy I know the tax payer.
There must be “black market” rating agencies to which buyers still go, where they can pay for a more honest, independent rating.
Hi Mish, nice blog layout but I miss the blog roll (real time feed from other blogs); that was a very nice feature.
There is a feed at the bottom to various sites and I do have a blogroll dropdown
Mish
Chicago is toast. It’s only a matter of time now (and not that long anymore). Thanks Mish. May I remind you to make sure your WP team has the ultimate protection on the back end of the blog to protect from hacks. I got blown up so bad a few years back I wound up going back to blogger. Thanks for all you do.
I am on their VIP platform
Do not believe it will be a problem
Thanks
Mish
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I propose that any bond that is rated by other than Moody’s or Egan should be interpreted by buyers as “deep into junk”.
Why else would an issuer accept another rating agency’s business?
Oh, and… HI JOE!!! (waves)
YOUR REPORTING ON THE CHICAGO SCHOOLS REALLY CREEPS ME OUT.
WHO WAS THAT SENATOR WITH HIS “UNAMERICAN COMMITTEE”? I THINK IT IS TIME TO RECONSTITUTE THAT COMMITTEE. THE PUBLIC SCHOOLS ARE A PUBLIC SERVICE AND IN PARTICULAR A SERVICE FOR INDUSTRY–WHICH WAS WHY THEY WERE CREATED IN THE FIRST PLACE. INSTEAD OF ISSUING BONDS CERTAIN TAXES SHOULD BE INCREASED AND PERHAPS CERTAIN SURCHARGES NEED TO BE APPLIED.
YA KNOW HOW YOU GOING LOOKING FOR ONE THING AND FIND SOMETHING ELSE. WELL CONSIDER THIS WHEN YOU TALK ABOUT FLOATING SCHOOL BONDS:
THEN WHAT IS THE RATIO OF CEO PAY TO MEDIAN WORKERS’ PAY?
$1034: $1 WAL-MART
422:1 CVS
283:1 DISNEY (POOR BAMBI LUCKY SHE EATS GRASS)
268:1 21ST CENTURY FOX
198:1 BOEING
150:1 DEERE
134:1 WALGREENS
110:1 MACY’S
115:1 NIKE (YOU KNOW THE “JUST DO IT” SNEAKER FOLDS)
104:1 TYSON FOOD
86:1 PEPSI
85:1 HCA HOLDING
91:1 VERIZON
76:1 CONOCO PHILLIPS72:1 EXPRESS SCRIPTS
58:1 HESS
AND THEN THERE IS THIS:
IN THE 1950IES THE TOP CORPORATED INCOME TAX WAS 50%. AND IN 2016 IT IS 35%. CAPITALIST COMPLAIN THAT TAXES ARE HOLDING DOWN JOB GROWTH BUT THEY CAN’T EXPLAIN WHY GE WAS REPORTED TO NOT ONLY NOT PAY TAXES BUT RECIEVE MONEY FROM THE GOVT!
IN 1950 IF YOU EARNED OVER $200,000 YOU PAID A 91% INCOME TAX.
IN 1960 IF YOU EARNED OVER $400,000 Y0U PAID A 91% INCOME TAX.
IN 1970 IF YOU EARNED OVER $200,000 YOU PAID 71% INCOME TAX.
IN 1980 IF YOU EARNED OVER $215,400 YOU PAID 71% INCOME TAX.
IN 1990 IF YOU EARNED OVER $162,700 YOU PAID 33% INCOME TAX.
IN 2000 IF YOU EARNED OVER $288,350 YOU PAID 39.6% INCOME TAX.
IN 2010 IF YOU EARNED OVER $373,650 YOU PAID 35% INCOME TAX.
IN 2013 IF YOU EARNED OVER $450,000 YOU PAID 39.6% INCOME TAX.
___________________________
KEEP IN MIND DEDUCTION AND WHAT WAS EXCLUDED FROM TAXATION CHANGED.
“SOCIALISM” – REGULATED MARKETS
THE PRICE OF SNEAKERS FROM FDR (1933) WOULD COST $100 TO LBJ (1969) WOULD COST $282.
“FREE MARKET” – UNREGULATED MARKETS
THE PRICE OF FROM NIXON (1969) WOULD COST $100 TO OBAMA (2015) WOULD COST $282.
THE REASON FOR HIGH TAXATION ON LARGE SALARIES WAS TO PREVENT CERTAIN GROUPS OF PEOPLE FROM SUCKING ALL THE MONEY OUT OF THE ECONOMY. BECAUSE IF YOU LOOK AT THE FREE-MARKET/ SUPPLYSIDE FOLKS STARTING IN 1970 NOT ONLY DID JOBS DISAPPEAR BUT SO DID FACTORIES. WHILE A LOT WENT TO ASIA, WHAT PEOPLE DON’T REALIZE IS THAT MOST LARGE CORP ASSEMBLE PRODUCTS PRODUCED BY SMALLER ONES, SO, WHEN THE BIG CORPORATION DISAPPEARS (MOVES OVERSEAS, GOES BANKRUPT, MERGED OR CANNIBALIZED) ALL THOSE SMALLER CORPORATION VANISH. SO ONE CAN’T HELP BUT NOTICE THAT LOWER TAXATION AND THE REDUCTION AND EVENTUAL ELIMINATION OF CAPITAL GAINS TAXES RESULTED IN THE SHRINKAGE OF THE AMERICAN CAPITALIST SYSTEM. IE, LOW TAXES = 3RD STATUS.
ANOTHER INTERESTING FACT IS THAT INFLATION DURING THE “SOCIALIST ERA” AND THE INFLATION DURING THE “CAPITALIST ERA” RESULTED IN THE SAME AMOUNT OF INFLATION. HMMMM?
I WOULD READ THAT TO MEAN THAT PROFIT TAKING DURING THOSE TWO PERIODS REMAINED UNCHANGED. BUT THAT HEAVY TAXATION MEDICATED THE EFFECT AND PREVENTED A TWO CLASS SOCIETY FROM EVOLVING.
I WOULD ALSO TAKE THAT TO PROVE THAT PROFIT TAKEN IS UNHEALTHY TO A CAPITALIST SOCIETY CAUSING FREQUENT BREAKDOWN IN THE SYSTEM.