STUMP » Articles » Chicago Bonds: Check Out These Investors Desperate for Yield » 27 May 2015, 20:49

Where Stu & MP spout off about everything.

Chicago Bonds: Check Out These Investors Desperate for Yield  


27 May 2015, 20:49

And some of them may even have been the proverbial old ladies:

Chicago sold about $674 million in bonds at yields approaching 6%, a sign that investors are demanding a premium to purchase the city’s debt following a recent downgrade by Moody’s Investors Service.

The nation’s third-largest city paid a top yield of 5.84% on Wednesday. That is as much as about 2 percentage points more in yield than a measure of A-rated municipal bonds, according to Municipal Market Data. Standard & Poor’s Ratings Services rates the city A-minus, an investment-grade rating, while Moody’s rates the city Ba1, a speculative grade.

The sale attracted $6 billion in orders, while proceeding with Mayor Rahm Emanuel’s plan to address the city’s debt portfolio and eliminate “a substantial amount of taxpayer risk,” according to a statement from Carole Brown, Chicago’s chief financial officer.

I bet Chicago is feeling pretty good about its chances to issue more bonds this year if $6 billion goes chasing $674 million — of course, at the yield of 5.84%. I would like to know who bid lowest yield, and what that amount was.

Back to the article:

The top yield paid by Chicago for bonds maturing in 2042 was lower than some government borrowers with distressed finances. Cash-strapped Puerto Rico last year sold $3.5 billion of junk-rated debt maturing in 2035 at an 8.72% yield.

That wouldn’t be so bad unless you realized just how badly off Puerto Rico is.

Puerto Rico has been laid low for nearly a decade by crippling debt and a near-perpetual recession that has triggered a migration to the U.S. mainland unmatched since the 1950s. Now, a growing number of people on the island worry that another crisis is looming: the collapse of the island’s health-care system.

Okay, that’s depressing enough. You can read the whole thing if you wish. In addition, Puerto Rico is increasing sales taxes. They’ve already lost 7% of their population to the mainland U.S. in the past decade. That’s almost as bad as Detroit.

But let us check out what was out there before the offering got put up.

First, what did the underwriters on the issue price the bonds at?

Underwriters initially priced $170.2 million of Chicago general obligation bonds on Wednesday with a top yield of 5.96 percent for bonds due in 2040 with a 5.75 percent coupon, according to a pricing scale obtained by Reuters.

So the market yield from the auction came in under that.

Back to the results:

Chicago initially offered bonds due in 2042 with a hefty 6 percent yield and 5.75 percent coupon. A repricing cut the yield by 16 basis points to 5.84 percent with a 5.50 percent coupon. The lower yield compressed the spread over Municipal Market Data’s benchmark triple-A scale for the U.S. municipal bond market to 264 basis points from 280 basis points. The city’s bonds had been trading about 300 basis points over the scale.

So, the coupon got cut, as did the yield. I rather imagine Chicago will go back to the well, if it can.

As to why I think that, let’s look at what @munilass has to say:

Borrowing money in order to borrow money

Bloomberg also notes that Chicago has the second-highest general obligation debt per capita among US cities at $3,047, following New York City at $5,500.

According to offering documents (available here), the city won’t be able to afford to make debt service payments on its outstanding bonds from available funds until 2019. The city has been borrowing money on a long-term basis to make debt service payments since before the financial crisis:

As I described at length in my earlier essay, How Chicago Has Used Financial Engineering to Paper Over its Massive Budget Gap, the city has also been using long-term debt to: (1) finance everyday expenses and maintenance; (2) finance judgments and settlements, including police brutality cases and retroactive wage increases and pension contributions for unionized employees; (3) restructure the city’s existing debt to extend the the maturities on its bonds far out into the future, in order to avoid having to pay the debt as it was coming due; and (4) provide slush funds for the city’s 50 alderman to undertake projects in their respective areas (i.e., pork).

State and local governments typically only issue bonds to finance the construction of capital projects — buildings and infrastructure with long useful lives that will benefit residents for generations. Chicago has incurred literally billions of dollars of debt where residents have nothing to show for it.

Excessive reliance on short-term debt

Besides a sharp loss in population (as what happened in Detroit), excessive reliance on short-term debt is a solid indicator of financial stress. Chicago has essentially used its credit lines as permanent source of funding in the sense that they are usually carrying a large balance and have frequently been utilized for non-capital expenditures. The city recently expanded its short-term borrowing program to $1 billion. For the sake of comparison, the city’s general fund operating budget is in the neighborhood of $3.3 billion.

Chicago is hardly exploring new territory here. All of the recent insolvencies in the municipal bond market have combined protracted fiscal mismanagement with a reliance on innovative financial products (e.g., interest rate swaps and pension obligation bonds). This epiphany continues to elude many market participants, especially those who believe credit analysis is as simple as financial ratios.

Perhaps Chicago will successfully navigate through this storm, but it is insane to disregard the risk involved.

Imagine paying your student loans with credit card cash advances (YOU DIDN’T HEAR THIS IDEA FROM ME).

Wait, wait — cash advances that you then take to the casino because you’ve got this sure-thing betting strategy that takes advantage of disparities between the true odds and the casino payoff odds because not only do you need to pay off your student loans but you’re accruing more debt because you like eating at the ritziest steak houses.

And then you have this really complicated strategy of moving money between different accounts to earn points, that supposedly matches your debt service cash flow needs. And you sell off your garage for one lump sum right now that someone else is going to rent out. (And then you find out you have to pay money back because they can’t get the rent they thought they would.) Now you’re looking for stuff to sell on ebay.


It’s amazing what insane things borrowers can get away with if they happen to be governmental entities.

Compilation of Chicago posts.

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