Chicago schools borrow millions at high interest to provide funds for 2017-18

The Chicago public school system has borrowed the hundreds of millions of dollars it needs to start the coming school year, at interest rates about four times what a typical government with better credit ratings would have to pay.

The Chicago Sun-Times reports that a week after the school district borrowed $375 million from J.P. Morgan at an interest rate of 6.39 percent, it secured another $112 million from the same lender at 6.41 percent. The short-term borrowing known as “grant anticipation notes,” eventually will be repaid by state block grant money owed to the Chicago district but not yet disbursed because of the ongoing budget stalemate in Illinois.

National dealt two-notch blow by S&P as BAM, Assured ratings affirmed

S&P Global Ratings on Monday delivered a two-notch downgrade to National Public Finance Guarantee Corp., and affirmed its AA ratings on both Build America Mutual, which had earlier been placed on negative watch, and Assured Guaranty.

S&P said it lowered its financial strength rating on National to A from AA-minus and its long-term counterparty credit rating on its parent company, MBIA Inc., to BBB from A-minus. MBIA's financial strength was affirmed by S&P at CCC.

Some market analysts said the cuts will prevent National from writing new business, which would leave only two active bond insurers.

The Pension Crisis And The Muni Bond Market

Underfunded pension plans grab the headlines. But that’s not what drives prices in the municipal bond market, according to Tom Doe. It’s the interplay between supply and demand – and right now yields are depressed due to a shortage of high-quality bonds.

“It’s all about investing the massive amount of money coming into this sector,” Doe said. He added that this is the biggest supply shortage since the fall of 2013.

Doe is the founder and chief executive officer of Concord, MA-based Municipal Market Analytics (MMA), an independent research firm that provides strategic market and credit research on the U.S. municipal market and industry. I spoke to him on June 23.

SANDAG Bet Against Big Banks — and Taxpayers Are on the Hook for Millions

• Interest-rate swaps cost public agencies millions of dollars. Now they’ve largely disappeared in the public sector.

• Many agencies have paid money to get out of swaps deals. SANDAG, however, has kept the bulk of its swaps – with their outsized monthly payments to banks on top of debt payments to actual bondholders – even as money runs dry for new projects.

It was 2005, and the recession hadn’t hit yet. Most taxpayers didn’t have opinions on financial derivatives. Few imagined major banks could ever go belly up. Even government agencies began drinking the Kool-Aid.

The San Diego Association of Governments was no different. Looking to maximize the possibilities for TransNet, its newly passed sales tax measure, the public agency did what others were doing: It played around with sophisticated financial arrangements that few understood.

SANDAG bet big that interest rates would go up. Instead, rates went down and stayed down – they’re still down. That unforeseen event – persistent and historically low interest rates – cost the agency millions.

As a result, SANDAG now has a roughly $100 million liability hanging over its head. It’s already spent $3.5 million out of pocket that it didn’t anticipate. And it spent $22 million to get out of a portion of its bad bet using borrowed money that will end up costing $42.5 million to repay.

Christie plan to give lottery to pension fund just a distraction

The pension fund would get the same $1 billion from the lottery or state budget. But for accounting purposes, the money counts more if it is being produced by an asset of the pension fund. So – presto chango! – the state’s unfunded liability would drop by $13.5 billion, says the Treasury Department.

This would only matter if it prompted debt-rating agencies to upgrade New Jersey (after years of downgrades) and reduce its borrowing costs. The bond analysis firm Municipal Market Analytics told Observer New Jersey that is unlikely. Sen. Jennifer Beck, R-Monmouth, sensibly prefers to hear from Moody’s or S&P before voting on the lottery plan.

Retirees, minimize your costs when buying bonds

But small investors can incur hefty trading costs even in higher-quality, less-obscure bonds. Research firm Municipal Market Analytics offers this example: Looking at a California general-obligation bond maturing in 2037, there were two inter-dealer trades on the morning of March 17 at nearly the same price: $112.73 and $112.67. Three minutes later, a customer bought $50,000 worth of the bonds at $115.10—2.2% more. Less than an hour after that, a large investor buying $6.9 million worth of the bonds got something much closer to the inter-dealer price: $112.99.

Such price discrepancies can make the muni market "very difficult for an individual investor," says Thomas Doe, president of Municipal Market Analytics. The market actually resembles a "flea market," he says, "because you have this eclectic product, very inconsistent supply and demand, and you're just trying to match the product with a buyer."

Chicago Public Schools borrow $275 million at sky-high interest rate

Matt Fabian, a partner at Municipal Market Analytics, said the 6.39 percent interest rate is about 4.5 percentage points “more than a ‘regular’ issuer would pay, but CPS left ‘regular’ two years ago.

“CPS has no regular market access so the price they pay to borrow is always the product of negotiation,” he added.

Goldman Sells American Dream in Unrated Municipal-Bond Deal

Investors purchasing the American Dream bonds will need to weather the potential pitfalls: The 1,136-page offering statement includes 36 pages of risks, ranging from whether the project will be completed on time to the “difficulty, expense, unfamiliarity and time-consuming nature" of getting to the center.

American Dream is across the highway from MetLife Stadium, the home of the National Football League’s New York Giants and New York Jets. Events at the stadium could adversely affect attendance.

Lisa Washburn, a managing director at Municipal Market Analytics, was skeptical that tourists coming to New York, with all of its culture, entertainment and shopping, would get on a train or bus to the Meadowlands, “a difficult to-get to destination in a relatively unattractive part of New Jersey."

“Parking and transportation is really substandard in this area," said Washburn.

New Jersey pension lottery plan is gamble: MMA

New Jersey Gov. Chris Christie’s proposal to used dedicated state lottery revenues to boost its underfunded pension system is not a viable solution, according to Municipal Market Analytics.

Christie has pushed the lottery plan since his February budget address arguing that that it would lead to an immediate $13 billion improvement in the pension fund’s unfunded liability. However, MMA partner Matt Fabian noted in a report released Tuesday that the proposal

Christie betting that lottery can bail out troubled pensions

Analysts and advocates say the deal — an arrangement that would be unique to New Jersey — probably won’t hurt, but there’s not a consensus on how much it might help.

“Where it does provide tremendous relief is optically,” said Lisa Washburn, managing director at Municipal Market Analytics, a firm that analyzes government bonds. “The numbers look better on a whole lot of levels. Whether or not they’re truly better is questionable.”

Since Christie took office in 2010, the state has contributed more than $6 billion to retirement funds to which past governors have often skimped on payments — or skipped them entirely. Still, the gap between the money expected to be in the funds and that which is owed to retirees has only grown. By any measure, it’s among the biggest unfunded pension liabilities in the country.

Puerto Rico Bond Traders Still Find Buyers Despite Epic Collapse

Since that filing, the 50- and 200-day moving averages for daily trade volume have increased by 17 percent and 6 percent, respectively.

“It has become more clear that there isn’t much money,” said Matt Fabian, a partner with Municipal Market Analytics Inc. “Maybe Puerto Rico investors were too optimistic in what they thought the control board would do or what Puerto Rico could theoretically pay them.”

While the securities are easily sold, some are still hovering near record lows. 

From Tax Codes to Traffic, a Megamall’s Risks

Sixty-nine percent of American Dream's 2.9 million square feet of space has been leased to tenants like Saks, Lord & Taylor, and Primark. There will also be a Nickelodeon amusement park and a DreamWorks water park.

Still, says Lisa Washburn, a credit research analyst for Municipal Market Analytics, the project should give any investor pause.

“I still remain skeptical about the ability for success for the project generally and specifically very concerned about the risks to bondholders,” she said.

S&P Downgrade Brings Illinois Closer to Junk--Update

Illinois also would have to make millions of dollars in termination payments on existing interest-rate swap contracts, according to S&P. Those penalties would be about $10 million in the event of a downgrade to junk by one rating firm, would reach $19 million if two firms gave the state a junk rating and could reach $108 million in the event of further downgrades.

"By letting the state get downgraded, Illinois's government is only making its own budget problems worse," said Matt Fabian, a partner at Municipal Market Analytics

Analysts for all three ratings firms have said that Illinois has significant economic strengths and that its deteriorating credit is in large part a result of political gridlock.

Muni-Bond Vultures Rethink Risks Lurking in Market's Junk Yard

Distressed muni-debt traders usually buy when the credit rating of a bond is downgraded to junk status. That’s when institutions, such as mutual funds, are forced to sell or otherwise long-term retail investors get spooked.

“Next time around, you bet that they’re going to be asking for lower prices when mutual funds want to unload something like Illinois,” said Matt Fabian, a partner with Municipal Market Analytics Inc. in Concord, Massachusetts.

“How the country will deal with municipal default is likely in its infancy,” Hatch said. “Ideas are forming, from a legislative and judicial standpoint, as to how we’ll handle large insolvent municipal entities.”

The flouting of constitutional rules may cause distressed muni-bond investors to insist on discounts, but it won’t scare them away from the market, Fabian said.

Municipal Bonds Richest in a Year as Supply Dries Up in Summer

The rally in municipal debt comes as analysts expect supply to continue to shrink in the summer months at the same time that cash-rich investors will have a hoard to invest. Citigroup Inc. analysts predicted that the market will shrink by $39.5 billion between June and August, while investors will receive $44 billion in interest payments.

"Because of the lack of supply relative to demand, and because of the relative height of nominal yields, its going to be hard for munis to project weakness over the summer," said Matt Fabian, a partner with Municipal Market Analytics Inc., in a telephone interview. "Left to their own devices, munis will be prone to rally."

Local Governments' Hidden Reason to Oppose Tax Cuts: Bank Loans

Some local governments have a hidden reason to root against President Donald Trump’s tax-cutting agenda: It could make their bank loans more costly, according to Municipal Market Analytics.

Municipalities have borrowed billions from banks to skirt the expenses associated with public bond offerings. But banks often include provisions enabling them to raise the interest rates if legal or regulatory changes diminish their returns. A cut in the corporate tax rate, for example, would likely result in a lower after-tax yield on a tax-exempt loan, potentially triggering “yield maintenance" provisions, wrote analysts at MMA, a Concord, Massachusetts-based independent research firm. 

“Given the current administration’s focus on tax-reform and/or tax cuts, borrowers that have these yield maintenance provisions could see their debt service costs rise," MMA wrote. 

Direct lending by banks has proliferated in the $3.8 trillion municipal market because states, local governments and non-profits can borrow at rates comparable to those on bonds, without the fees or disclosure requirements associated with securities sales.

Because loans aren’t classified as securities, states and cities aren’t immediately required to disclose them, despite the risk they can pose to bondholders and taxpayers. For example, banks can demand accelerated principal and interest if a payment is skipped or a government’s cash falls below a specific target, which could push the borrower into a liquidity crisis if it can’t cover the bills. 

MMA estimates that some $180 billion of such loans have been made. But given the lack of disclosure, it’s impossible to know how many borrowers might be subject to rate increases if federal taxes are cut, MMA wrote.

Under fire, Emanuel defends ‘payday loan’ plan to borrow $389M for CPS

“Borrowing against uncertain and late categorical funding from the state … may allow the district to remain open through the end of the school year and make its statutory pension payment, but it will come at a heavy price, both in terms of a high borrowing cost and the reputation of CPS. Worst of all, it does not help with the Chicago Public Schools’ budget shortfall next year and will, indeed, make it worse,” Msall said.

Matt Fabian, a partner at Municipal Market Analytics, said CPS is already the “main risk to the city from a triage perspective” and, therefore, the city would have been better off “giving” the district the short-term money it needs.

He suggested the city either borrow the money for CPS or raid the tax-increment-financing (TIF) surplus yet again, just as Emanuel did to the tune of $87.5 million to stave off another teachers strike.

“That’s a better option than paying 8.5 percent interest and taking more risk. There’s no reason to assume that the state grants are gonna be provided anytime soon,” Fabian said.

“The problem for Chicago and CPS is that the state is simply not going to help or the state is unwilling to help. So, the city and the school district need to work out plans of their own. Because they continue to rely on the state, they keep winding up in this same situation.”

Fabian urged Emanuel to move quickly to identify a permanent, local source of revenue for the Chicago Public Schools.

“Speaking for Wall Street, the street is impatient to get to a full-funding scenario. Investors want the long-term solutions produced in the short-term. As far as figuring out what taxes to raise and what spending to cut, full speed ahead,” he said.

The Chicago Sun-Times has reported the mayor is considering taxing high net-worth individuals, downtown businesses or both to generate the $400 million-to-$600 million needed to put CPS on more solid financial ground.

“That is one of the easiest things for Chicago to tax because they have had strong growth downtown. That would seem one of the more resilient areas of the economy to tax. It’s not unreasonable to look there first,” Fabian said.

“There isn’t much tax capacity in the neighborhoods and, from a national perspective, Chicago’s economy is very healthy. So, it could handle a higher tax burden, especially downtown.”

Fresh Off Another Downgrade, Connecticut Has a Plan to Lower Borrowing Costs

Nappier wants the state to start offering investors revenue bonds that are paid back directly from the state’s income tax revenues. Called tax-secured revenue bonds, these new bonds would be offered in place of general obligation bonds, which are backed by the state’s general revenue collections. Nappier’s office believes the dedicated income stream would mean the bonds would fetch ratings as high as AAA, resulting in a better interest rate and lower debt service costs.

The idea has received mixed reviews.While some observers call it a product that will offer comfort to bondholders wary of Connecticut’s troubles, others say it’s a “financial engineering gamble” designed to game the market. “To create something out of nothing -- they’re not being more fiscally responsible by doing it this way,” says Municipal Market Analytics’ Lisa Washburn.

Belle Haven Investments’ Tamara Lowin says Nappier’s proposal is simply another way to assure investors they’ll get their money back with interest. “This market loves the transparency of being able to see a direct revenue stream,” she says. “It’s a way to offer a credit designed with the ratings agencies in mind.”

But Washburn isn’t so sure that potential investors will be reassured by the new bonds and be willing to take a lower interest rate on the debt. “The likelihood that Connecticut will ever default and be in a situation where you have to test the structural provisions is really, really low,” she says. “But would I want to give it a pricing benefit as an investor? It’s definitely questionable.”

Muni Bond Ripple Effects Of The Puerto Rico Bankruptcy

There are major ripple effects as a result of this bankruptcy, and they affect large mutual funds, tax-free bond strategies for many retired investors, and scattered individual bond issues. The holistic concern is that risk is now being added to a sector where traditionally risk was considered to be extremely low.

That's because the Puerto Rico default is not only the largest in American history, but it comes on the heels of Detroit, Stockton, and numerous other municipal defaults. This Moody's report provides information on the largest defaults up through 2014, and this one for 2015. In his report on 2016 defaults, including Puerto Rico, Matt Fabian of Municipal Market Analytics says, "This is a dramatic reshaping of the industry's overall risk profile and will doubtless drive at least somewhat more conservative investor behavior in the future, in particular as regards large distressed governments like IL, NJ, CT, KY, and Chicagoland credits."

Puerto Rico Debt Donnybrook Kicks Off With Default Squabble (1)

Emma Orr, Steven Church and Michelle KaskeMay 11, 2017 9:31 am ET

(Bloomberg) -- Dealing with Puerto Rico’s crushing debt has started to resemble a circular firing squad.

Simply put, the bankrupt island can’t pay everything it owes, so creditors are taking aim at each other as they squabble over who will get what’s left. But the debt’s size and the tangled process invented to rescue Puerto Rico mean there’s no established rule book to shape what comes next.

Holders of general-obligation debt have declared their right to be paid first, owners of sales-tax bonds are squabbling with one another over who deserves priority, and they’re all up against the commonwealth’s leaders, who want the cash for essential services. Amid this melee, Puerto Rico’s federal overseers will have to choose between paying U.S. hedge funds everything they’re owed or keeping schools, water and electricity running.

“There just isn’t enough money,” said Matt Fabian, a partner with Municipal Market Analytics Inc. in Concord, Massachusetts, who foresees a chaotic brew of lawsuits, federal interventions and politics. “Nobody has any idea what’s going to happen.”

All told, Puerto Rico has about $74 billion in debt and $49 billion in pension liabilities. Hedge funds holding $1.4 billion of general-obligation bonds, including Aurelius Capital Management and Monarch Alternative Capital, have already sued to get overdue principal and interest. On the other side, owners of $17 billion in sales-tax bonds, including Tilden Park Capital Management and GoldenTree Asset Management, have entered the fray. They’ll meet for the first time in court on May 17 in San Juan.

Default Notice

The dispute over the sales-tax bonds, named Cofinas after the agency that issued them, began in earnest May 4. That’s when the trustee, Bank of New York Mellon Corp., sent a notice of default to the authority that sold the bonds. The object was to keep the government from diverting the sales-tax revenue to other purposes before it pays what it owes to investors.

The New York-based bank acted after weeks of pressure from senior bond owners who urged the trustee to safeguard their claims. In the process, junior bondholders were irked because the default notice could mean no payments for them until the senior bondholders are paid in full. The notice sets a 30-day deadline for a response from Puerto Rico, which is supposed to pay about $256 million of principal and interest on Aug. 1, according to data compiled by Bloomberg. 

Puerto Rico’s status as a commonwealth means it’s not subject to traditional bankruptcy laws. Instead, the island filed for the next best thing to deflect claims, called Title III. It’s an in-court restructuring based on the U.S. bankruptcy code that was created under Puerto Rico’s Promesa law last year. But it’s never been used before, which means any cuts imposed by U.S. District Court Judge Laura Taylor Swain will be more likely to face years of appeals than a typical case.

Delayed Filing

Puerto Rico’s initial Title III filing on May 3 didn’t include Cofina. If it had, BNY Mellon may have been prohibited from sending its May 4 default notice. But the oversight and management board didn’t file its separate Title III action for Cofina until May 5, giving the bank a window to declare the default.

The delay means it’s unclear whether the Title III filing voids BNY Mellon’s default notice, as well as a separate default notice sent by Ambac Assurance Corp. on May 1. Regardless, BNY Mellon and senior creditors are prepared contest a court’s decision if it’s not in their favor, according to a person familiar with the matter, who asked not to be identified discussing private information. The government hasn’t said how it will respond.

“As a public policy, legal defense strategies are not discussed until they are presented in judicial forums,” Yennifer Alvarez, a spokeswoman for Governor Ricardo Rossello, wrote in an emailed comment.

The senior bondholder group, which controls about one-third of the senior Cofina bonds, is led by hedge funds Whitebox Advisors, Tilden Park Capital Management, GoldenTree Asset Management and Merced Capital, according to Susheel Kirpalani, a lawyer at Quinn Emanuel Urquhart & Sullivan who represents the group.

Debt Due

For investors, there’s a lot at stake. Cofina holders are owed more than $8 billion in debt service through 2026, with $704 million in payments due in the next fiscal year, which starts in July, according to the commonwealth’s fiscal plan.

The territory owes all bondholders $33.4 billion in debt payments between now and 2026, according to the plan, but it proposes to pay only about $8 billion. The government hasn’t said how bondholders should divide those payments, or which group is first in line.

“This is a government restructuring, not a court one, so the government will be in the driver’s seat,” Fabian said. “Creditors will not be heard to the extent they’re saying, ‘let’s do it a different way.’ Those arguments won’t have any standing in a court.”

Owners of junior Cofinas could be left vulnerable. BNY Mellon holds a trustee reserve fund of sales-tax revenue with about $400 million, more than enough to handle the upcoming August payment, according to people familiar with the matter.

But because of the default notice, junior bondholders are unlikely to be paid, in order to safeguard claims of the senior Cofinas, said the people, who asked not to be identified discussing private transactions. Given the limited funds available for debt repayment, there’s a chance the subordinated holders could get little or no recovery. A representative for BNY Mellon declined to comment.

What’s more, general-obligation bondholders claim that the entire Cofina structure violates the island’s constitution, and all the sales-tax revenue is owed to them. If the general-obligation claims are supported in court, all of the Cofina debt could be ruled invalid and investors could receive nothing at all.

(Updates with BNY Mellon location in seventh paragraph.)

--With assistance from Rebecca Spalding

©2017 Bloomberg L.P.