Current senior bondholders have lost seniority in Chicago

The [Chicago] schools have created a new bond which guarantees debt service via a third entity that extracts debt first.  But it extracts the debt needed for buyers of the constructed bonds, not for older holders who go still vie for the same tax base.

The new bond structure marks the second time in a year that Chicago has issued such tightly structured debt. Last winter, Chicago’s school district—a legally separate municipality, despite relying on the same tax base as the city—issued a half-billion dollars in bonds through a new instrument designed, as Reuters put it, “to separate the debt from the district’s severe financial woes and protect it in a potential bankruptcy filing.” Investors in the new school bonds rely on revenues from a specific capital-improvement tax, again avoiding Chicago’s junk-level credit. Chicago constructed “what they consider this strong bankruptcy-remote structure because of the acute and growing risks perceived by investors related to the general-obligation pledge,” says Bill Bonawitz, director of municipal research at PNC Capital Advisors. Bond raters rewarded the school bonds with a grade of “A,” eight steps above the city schools’ credit rating at the time; as of mid-September, the bonds traded at just above 4 percent annual interest, lower than the school district’s overall cost of borrowing.

This is implied bankruptcy, a ex ante admission that debt service cannot be made.  Existing bondholders should be quite worried.