(Bloomberg) -- Mayor Lori Lightfoot has been studying lots of numbers as she prepares Chicago’s budget, and her first big test may come from the city’s teachers this week.
Chicago Teachers Union members begin casting ballots on Tuesday on whether or not to authorize a strike. The union has rejected an offer for a 16% pay raise over five years and is also asking for more staff such as nurses, librarians, social workers and special education teachers after years of cuts. If three-fourths of members vote yes, the union must give the Chicago Board of Education a 10-day notice, meaning Oct. 7 would be the first day a walkout could start.
“There’s a lot of interest in how it’s being handled, and if she can negotiate to avoid a strike,” Howard Cure, managing director of municipal bond research at Evercore Wealth Management in New York, said regarding the mayor and the talks. It’s “the first test as far as fiscal issues that investors would be concerned about.”
Lightfoot is trying to figure out how to fill an $838 million hole in the cash-strapped city’s budget, which is separate from the school district’s spending plan. Still the two issuers’ fates are intertwined as the board is appointed by the mayor and the two bodies share a tax base. The ongoing labor tensions increase the risk of higher costs for the junk-rated school district that is already struggling with shrinking enrollment and massive pension liabilities.
“Both the financial risk and the reputational risk is high for the city,” Jason Appleson, a portfolio manager for PT Asset Management, which has more than $1 billion in municipal assets under management, including a small amount of insured board debt, said in an email. While the market appears to be “largely brushing off” the risk of a prolonged strike, he said he thinks such an “outcome with a non-zero probability” should be taken into account.
The third-largest U.S. school district has benefited from improving finances after the state of Illinois increased its funding for the school system in 2018. The state support has paid off. Last month, Fitch Ratings and S&P Global Ratings raised the Chicago Board of Education’s ratings, and the board saw a smaller penalty when it sold about $350 million of fixed-rate general-obligation bonds earlier this month. The spread over benchmark on the deal’s 5-year bonds was about 55 basis points lower than the premium paid on debt with a similar maturity sold by the board in November, according to data compiled by Bloomberg.
Investors are watching the impact of a potential walkout on the district and the indirect consequences for the city, according to Evercore’s Cure. Bondholders are concerned about what it could mean in terms of higher property taxes and potentially fueling a longer-term exodus of residents from the city, he said. Chicago’s population has dropped 0.8% since 2014, according to U.S. census data. Such issues have kept Evercore from buying the district’s debt, he said.
“A thriving city needs a good public school system,” Cure said in a telephone interview. “It’s the same tax base.”
The tense talks are getting some national attention. Vermont Senator Bernie Sanders, a Democratic presidential candidate, is scheduled to attend a rally Tuesday evening hosted by the Chicago Teachers Union and several other groups “to support the struggle for equity and educational justice for CPS students and the workers who serve them,” according to a union statement.
“We value you and I think we’ve shown that by a very fulsome compensation package,” Lightfoot said in response to a reporter’s question on Tuesday about what she would say to teachers as they cast ballots. “There’s absolutely no reason why we shouldn’t get a deal done.”
“If I personally need to be at the table, I will clear the decks of my schedule to be there,” Lightfoot said. “If we need to have more bargaining sessions, let’s do it.”
Higher-than-expected labor costs could threaten the balance the district has achieved between expenses and revenue. While S&P in August raised its rating for the board by one step to BB-, three levels below investment grade, the union fight limited the board’s upgrade.
“We stopped short of raising it an additional notch, waiting to see the impact of the teacher settlement on the fiscal 2020 budget and beyond,” Blake Yocom, an analyst for S&P in Chicago, said in an interview. Given a new mayor and relatively new leadership at the union, a “cloud of uncertainty” hangs over what will be in the final agreement, Yocom said.
Chicago teachers had a one-day walkout in April 2016, and in 2012 the union staged the city’s first public school strike in 25 years. The outcome of this week’s strike vote could impact the board’s ability to manage labor costs, its largest expense, said Arlene Bohner, senior director and manager for U.S. state and local government ratings for Fitch Ratings.
“This will be the board’s next big challenge: to manage rising spending pressures without resorting to unsustainable budgetary measures or impairing their newly-restored reserves,” Bohner said. “From a credit perspective, a positive outcome would be a contract that provides some budgetary certainty, is affordable and doesn’t trigger a return to budgetary structural imbalance. A negative outcome would be the opposite.”
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