NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a 'B+' rating to the following Chicago Board of Education, IL's (the board) bonds:
--$795.5 million unlimited tax general obligation (ULTGO) bonds series 2016A;
--$79.5 million ULTGO bonds taxable series 2016B.
The bonds are scheduled to sell the week of Jan. 25, via negotiation. Proceeds will finance various capital projects, swap termination payments, reimbursements of reserves and short-term lines of credit used to pay swap termination payments, reimbursement of the general fund for prior capital advances, and the fixed rate refunding of variable rate debt.
Fitch also downgrades to 'B+' from 'BB+' approximately $6.1 billion of outstanding ULTGO bonds.
The Negative Watch is removed, and a Negative Rating Outlook is assigned.
Most of the bonds are payable in the first instance from unrestricted general state aid. All are general obligations, payable from unlimited ad valorem taxes levied against all taxable property in the city of Chicago.
KEY RATING DRIVERS
LACK OF MATERIAL PROGRESS: The downgrade reflects the limited progress Chicago Public Schools (CPS) has made in addressing a structural budget gap approximating 20% of spending for the current fiscal year. Following substantial drawdowns in fiscal years 2013-2015, reserves will likely be fully depleted by the end of fiscal 2017.
SEVERE OPERATING IMBALANCE: CPS has a relatively inflexible expenditure profile and little to no independent ability to raise revenues. Substantial changes are necessary to support ongoing operating and fixed cost spending. Options within the board's control are limited absent meaningful solutions with other parties, which Fitch believes are unlikely in the near term.
WEAK LIQUIDITY: Fitch will be monitoring access to external liquidity as internal cash and investments have been greatly diminished, requiring increasing levels of short-term borrowing to finance on-going operations.
PENSION LIABILITY WEAKNESS: Large pension liabilities were exacerbated by a three-year payment deferral that caused a dramatic jump in annual contributions beginning in fiscal 2014. Most options for relief are dependent on actions by the state, which is plagued by political disagreements and its own challenged financial position.
POOR LABOR HISTORY: The last contract negotiation with the Chicago Teacher's Union (CTU) was highly acrimonious and involved a strike. Talks regarding a new agreement to replace the recently expired contract have so far yielded no resolution and the CTU has authorized another strike.
SOLID ECONOMIC FUNDAMENTALS: Chicago serves as the economic hub for the Midwestern region of the United States with a highly educated workforce and improving employment trends. The city, county and state finances remain challenged, mainly due to a large long-term liability burden.
UNFAVORABLE DEBT POSITION: The district's debt levels are above average with very slow amortization. The current issue increases debt levels and includes a debt restructuring which will further exacerbate this challenge.
RATING BASED ON GO PLEDGE: The 'B+' rating relies upon the general obligation, unlimited tax pledge which serves as the backup to the primary pledge of unrestricted general state aid (GSA). Fitch believes that the mechanics of the GSA pledge do not insulate bondholders from the issuer's general credit.
REVERSING STRUCTURAL IMBALANCE: A lack of progress towards resolving CPS's large structural imbalance would put further negative pressure on the rating.
MARKET ACCESS: Reliable market access is important to near-term stability. Fitch will monitor the district's ability to access external financing for both liquidity and capital purposes.
CPS serves almost 400,000 students in 664 schools in school year 2014/2015 in a district that is coterminous with the city. Enrollment trends are slowly declining.
LIMITED OPTIONS TO ADDRESS LARGE BUDGETARY GAPS
Fitch believes the size of the operating shortfalls in fiscal 2014 and 2015, and the magnitude of the gap in fiscal 2016 underscore the difficulty of balancing fiscal operations. CPS recorded a $724 million (13%) net general fund operating deficit after transfers for fiscal 2015, somewhat more positive than the $862 million budgeted draw. The operating deficit is symptomatic of a chronic structural imbalance which persists despite implementation of a far-reaching and controversial school closure plan in 2013, an increase in property tax revenues to the statutory cap, and sizable reductions in non-education spending. The projected gap for fiscal year 2017 is over $1 billion, or about 20% of spending, which would wipe out remaining reserves and likely exhaust available lines of credit.
The district ended fiscal 2015 with unrestricted reserves of about $254 million (4.5% of spending) in the general fund. This follows a drawdown in fiscal 2014 of $513 million (9.4% of spending). Budgetary balance in recent prior years has relied largely on non-recurring measures.
Management's efforts to reduce costs have yielded some savings and included school closures as well as reductions in central office and other administrative spending, while generally avoiding cuts to classroom spending. The potential for additional savings in these areas appears to be limited.
Furthermore, Fitch believes the 2012 CTU strike made apparent the poor working relationship between the board and CTU. The agreement reached in 2012 expired June 30, 2015. Prospects for achieving savings from labor negotiations are dim, as a strike has already been authorized by the CTU membership.
FISCAL 2016 BUDGET UNCERTAINTY
The fiscal 2016 budget closed the $1 billion gap with a mixture of recurring and non-recurring elements. A $138 million appropriation of reserves and $200 million of cuts have already been implemented and the current issue includes $200 million of debt restructuring budgetary relief. The budget also assumed $480 million of additional pension support from the state, the receipt of which appears speculative to Fitch given the current impasse at the state level. CPS's pension payment is a large $675 million for fiscal 2016.
GAPS FOR FISCAL 2017 AND BEYOND WIDEN
CPS has identified a $1.1 billion budget gap for fiscal 2017, which it proposes to be addressed with a mixture of increased funding from the state, increased local funding, a new $170 million pension levy (requires state legislative approval), and negotiated employee benefit restructuring. If any of these are not realized, school funding cuts would be implemented.
Other avenues for revenue enhancement are limited, although the city has authorized a $45 million property tax levy for school capital improvements which does not require state approval.
Management has requested a change in the state education funding formula to increase state aid. A bill has been introduced to the state legislature proposing a blue ribbon commission to examine this issue, but Fitch does not expect resolution in the near term.
If structural solutions prove unattainable the district may undertake another debt restructure and/or finance its pension payment. Both would result in increased longer-term costs, and thus would be considered a negative credit factor by Fitch.
Even with significant spending cuts the district will be highly dependent on short-term borrowing to maintain positive cash flow. Liquidity has declined dramatically from $1.1 billion of cash at the close of fiscal 2013 to $150 million at the end of fiscal 2015. The decline was exaggerated by the use of cash to pay for capital projects that are being reimbursed by the bonds now offered and the acceleration of vendor payments that were partially reimbursed in fiscal 2015.
Liquidity continues to deteriorate with negative cash balances for much of fiscal 2016 absent outside support. The district plans to use liquidity facilities for ongoing operations in fiscal 2016 and likely beyond. Currently, the district has $935 million of short-term debt outstanding, some of which (relating to payment of swap terminations) may be partially repaid with the current offering. Fitch will monitor the district's ability to access external markets for both this short-term borrowing and planned long-term borrowing.
PENSION LIABILITIES CONSISTENT WITH WEAK REGIONAL NORMS
A combination of lower-than-expected investment returns and payment deferrals for the CTU plan granted by the state for fiscal years 2011-2013 have weakened the district's pension plan. As of the June 30, 2015 CAFR, plan assets represented 53.2% of liabilities. The pension payment rose dramatically in fiscal 2014 to $613 million versus $245 million in fiscal 2013, to bring payments up to the level statutorily required to increase the CTU plan's funded ratio to 90% by fiscal 2059. Fitch does not believe this is an aggressive goal with respect to addressing the unfunded liability; however, the district is still finding it difficult to incorporate this increased payment into the budget. The fiscal 2016 contribution is $675 million. Fitch is concerned not only about these plans but other city, Cook County, and state of Illinois plans which are all poorly funded and draw upon the same resource base.
Other post-employment benefits (OPEB) are similarly underfunded but annual payments are statutorily capped at $65 million.
HIGH DEBT, SWAP TERMINATION TRIGGERED BY DOWNGRADE
The district's overall debt levels are high at 8.5% of market value, with slow amortization of 31% in 10 years, the result of long-dated debt and restructurings. The reduction in variable rate debt to 13.5% (after the current transaction) from 40% in the last several years is a positive credit development.
Downgrades last year resulted in termination events for eight of the district's 10 swaps. All 10 swaps have been terminated. The district drew upon reserves and short-term borrowing to fund the termination payments. Importantly, the district is no longer exposed to rating trigger risk.
Proceeds of the current issue will pay down approximately $176 million of short-term borrowing relating to prior swap terminations and debt restructuring. Approximately $392.6 million of the current issue will reimburse the general fund for prior capital expenditures and fund future expenditures.
Carrying costs for debt service, OPEB and the full required pension contribution were a moderate 18.8% of governmental spending in fiscal 2015. Costs will likely stay relatively controlled due to the slow amortization of the pension obligation, assuming the full required contribution is paid each year.
ECONOMIC FUNDAMENTALS SOLID
Chicago ('BBB+', Negative Outlook) serves as the economic and cultural hub for the Midwest region, and maintains good prospects for long-term stability if not growth. The city has gained almost 50,000 jobs since 2010 primarily in professional and business services despite reductions in both manufacturing and public service. Chicago's population totaled 2.7 million in 2014, down 6% from the 2000 census, but still accounts for 21% of the state's population.
Socioeconomic indicators are mixed with elevated individual poverty rates, average per capita income levels, but strong educational attainment levels. As of November 2015, the city's unemployment rate was 5.8%, consistent with the state, and down from 6.5% a year earlier.
Additional information is available at 'www.fitchratings.com'.
Fitch recently published an exposure draft of state and local government tax-supported criteria (Exposure Draft: U.S. Tax-Supported Rating Criteria, dated Sept. 10, 2015). The draft includes a number of proposed revisions to existing criteria. If applied in the proposed form, Fitch estimates the revised criteria would result in changes to less than 10% of existing tax-supported ratings. Fitch expects that final criteria will be approved and published by the end of the first quarter of 2016. Once approved, the criteria will be applied immediately to any new issue and surveillance rating review. Fitch anticipates the criteria to be applied to all ratings that fall under the criteria within a 12-month period from the final approval date.
In addition to the sources of information identified in Fitch's applicable criteria specified below, this action was informed by information from Creditscope, Lumesis, IHS Global Insight, and Zillow Group.
Exposure Draft: U.S. Tax-Supported Rating Criteria (pub. 10 Sep 2015)
Tax-Supported Rating Criteria (pub. 14 Aug 2012)
U.S. Local Government Tax-Supported Rating Criteria (pub. 14 Aug 2012)
Dodd-Frank Rating Information Disclosure Form