Week of 11/11/2019

Chicago Teachers Contract ‘Manageable’ Near Term With Long Term Challenges… Illinois’ Yield Penalty Shrinks… Favorable Demographics Boost Senior Living Housing Bond Prospects… FBI Crack Down On Puerto Rico Govt Corruption… Voters Approve Fewer Local Gov’t Bonds Amid Shrinking Ballot… Longest Munis Reap Most Amid Record Muni Inflows…

Chicago Teachers Contract ‘Manageable’ Near Term With Long Term Challenges…The new five-year contract appears manageable based upon Chicago Public Schools’ (CPS) fiscal 2020 budget. The $1.6 billion price tag of CPS deal with teachers is much lower than the $2.4 billion package the teachers’ union sought. ‘Existing property taxes’ will fund the bulk of the higher cost. “Under our current property tax levies, we have seen additional revenue between $100-200 million a year ($181M in FY18 and $102M in FY19). In the years ahead, we expect to see similar levels of growth, which on its own would cover the approximately $500 million in annualized additional spending by the end of the contract,” CPS stated. CPS property tax levy has grown to $3.1 billion in fiscal 2020 from $2.3 billion in 2016, per CPS. CPS also expects to get roughly $60-70 million additional a year under the new state aid formula and could reallocate existing spending in the range of $30 million-$40 million. Annual contracted cost increases start at $115 million in fiscal 2020 (2% of fiscal 2018 spending) and reach $504 million (9.1% of fiscal 2018 spending) by the end of the contract for a cumulative estimated increase of $1.6 billion. Several contract requirements such as additional staffing are to be phased in over five years allowing budgetary flexibility. CPS Fy20 budget was increased moderately after taking into account savings from six canceled school days and additional transfers from Chicago’s taxincrement districts. Some funding was built into the original budget to accommodate the expected contract and CPS has accumulated reserves over recent years. The teachers’ contract is expected to be ratified on November 15 followed by a budget amendment on November 20. The $1.6 billion price tag of the contract will widen CPS structural gap through 2024. CPS has articulated a credible, albeit likely difficult to implement, plan to close the ongoing annual budget gap through the end of the contract in 2024 per S&P. CPS gradual financial progress had recently brought a positive general fund balance. It is uncertain if CPS finances could improve in fiscal 2021-24. Illinois state aid is an important part of CPS credit quality. CPS Bonds are rated S&P ‘BB-’ with a positive outlook, Moody’s ‘B2’ stable outlook and Fitch ‘BB’ with a stable outlook. S&P expects that although upward rating movement could be delayed, the ‘structural gap created by the contract is not insurmountable’ and, is predicated on Illinois state aid.

Illinois’ Yield Penalty Shrinks…Illinois, the lowest-rated U.S. state, saw its yield penalty shrink by about 15 basis points last week. A new offering of $750 million Illinois General Obligation (GO) bonds with a 5% coupon saw a yield penalty of 140 basis points down from a three-month average of 160 basis points. Amid low interest rates, yield-starved investors aggressively sought the Illinois bonds offered last week driving down yield. The new $750 million GO bonds are the first bond issuance for the $45 billion ‘Rebuild Illinois’ capital plan approved by legislature. The ‘Rebuild Illinois’ plan relies on nearly $21 billion in borrowing, $10 billion in federal funds and pay-go funding. The state recently warned in its five-year forecast that its structural deficit will swell to more than $3 billion in five years. Next November, voters will decide on progressive taxes that could boost recurring state revenue. “The State of Illinois is very pleased to have received such a strong response from the municipal bond market. We were pleased to have entered the market near historic low interest rates and with solid investor demand and the results reflect a low all-in interest cost,” the state’s director of capital markets, Paul Chatalas added that Illinois’s bonds have “key bondholder protections backed by a large, diverse and stable economy.”

Favorable Demographics Boost Senior Living Housing Bond Prospects…Generally stable outlook for senior living housing bonds is driven by relatively stable occupancy in 2018 per S&P. Strong demand for senior living comes from favorable demographics and a robust housing market. Over reliance on non-operating income such as investment income could increase risks for senior living providers. Ongoing capital investments indicate that plant age could remain relatively stable or improve over the next few years per S&P which expects providers to continue to benefit from a solid U.S. economy, although the rising recession risk could challenge both operations and capital plans. Competitive providers focus on plant upgrades and cost management remains a significant factor for generating solid operating performance. Some variance in short-term vacancies comes from the nature of the business, long-term occupancy trends could be telling. Local governments act as conduits to allow not-for-profit corporations to issue tax-free bonds to finance senior living housing. Such bonds typically offer higher yields and carry higher risks.

FBI Crack Down On Puerto Rico Govt Corruption…The FBI arrested a Puerto Rico senator and seven others on charges of theft or bribery concerning programs receiving federal funds. In return for work on the Senators’ election campaign, several municipal employees were allowed to miss work. U.S. Attorney for the District of Puerto Rico said that the prosecution serves as a warning to other public officials that those involved in embezzlement schemes will be punished. The arrests come as Puerto Rico recovers from recent political turmoil that saw the resignation of the Island’s previous governor following massive protests spurred in part by anger over corruption.

Voters Approve Fewer Local Gov’t Bonds Amid Shrinking Ballot…At least $17 billion of bond sales for schools and public transportation were approved by voters last week. Voters were asked to decide on $34 billion bond referendums in hundreds of local government elections nationwide. That’s less than half of the amount of bond referendums on the ballot last year. Voters in fast-growing Texas approved the highest amount of new bond financed projects and supported the creation of Flood Infrastructure Fund to mitigate climate risks. New York voters approved a measure to create a city savings account to help shield residents from tax hikes and program cuts during the next economic downturn. The largest approved bond measures include $1 billion for Ann Arbor, MI schools and $600 million for affordable housing in San Francisco. Typically, voters have approved about 70% of bond measures since 2000.

Longest Munis Reap Most Amid Record Muni Inflows…Long term muni bonds have pulled in $49.8 billion in 2019, the most since 1992. Roughly two-thirds of every dollar invested in tax-free bonds this year has come to long term muni bonds fueling gains for bondholders. Municipal bonds have pulled in $76 billion of inflows in 2019. Inflows to municipal bonds have continued for 44 weeks-in-a-row, a record level of straight inflows.

Compare 30-Year taxable U.S. Treasury yield 2.42% to 30-Year tax-exempt muni bond yield “AAA” 2.27%; “AA” 2.54%; “A” 2.70%; “BBB” 3.2%. For investors in the 35% tax-bracket, a 3.2% tax-exempt yield is equivalent to a 4.9% taxable yield. Top rated tax-free bonds yield 94% of comparable taxable U.S. Treasuries.