Two of the highest profile and liquid names in the municipal high-yield market are the City of Chicago and the Chicago Public Schools (CPS). Both credits have been trending positively since the height of the COVID-19 pandemic; however, momentum could be shifting as the federal stimulus money expires and mounting cost pressures persist. Projected out-year shortfalls are material, and while we believe the improved reserves will provide some runway, we are closely watching several upcoming credit catalyst events. As a result, constant deep dive analysis on fundamentals, relative value and technicals are required to add shareholder value.
Mayor Brandon Johnson and his administration recently released the City of Chicago 2025 Budget Forecast which highlights a year-end projected shortfall of $222 million and out-year shortfalls in the range of $982 million to $1.3 billion through 2027. Projected shortfalls are materially large and are approaching the pandemic high level. To put things into perspective, the fiscal year 2021 pandemic-related deficit of $1.2 billion was the largest in the city's history, and current out-year shortfalls are expected to be either near or exceed this amount.
Source: City of Chicago 2025 Budget Forecast.
CPS, a sister agency of Chicago, is also facing fiscal challenges with projected out-year shortfalls upwards of a half-billion dollars ahead of a new Chicago Teachers Union (CTU) bargaining agreement. Significantly, shortfalls could end up materially higher depending on the final CTU contract outcome. For example, at a recent public bargaining session, CPS' presentation suggested that if 52 of the 700 CTU contract proposals get implemented, deficits could reach $2.9 billion next year and $4 billion by 2030. Adding another layer of complexity, these headwinds are coming at a peculiar time as recent state legislation requires CPS to decouple from the city.
Impact of New Labor Contract Costs on Projected Budget Deficit
Source: Chicago Public Schools Finance Public Session Presentation, as of Aug. 13, 2024.
Bottom line: The City of Chicago and CPS are entering a more challenging environment. We believe credit volatility may return absent long-term structural solutions, which in turn could result in better entry points relative to current spread levels. Therefore, constant deep dive analysis on fundamentals, relative value and technicals are necessary to add shareholder value.
