Market Overview

Fitch Rates Chicago Board of Education, (IL) ULTGOs 'B+'; Outlook Negative

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NEW YORK--(BUSINESS WIRE)--

Fitch Ratings has assigned a 'B+' rating to the following Chicago Board of Education, IL (CBOE) unlimited tax general obligation bonds (ULTGOs):

--$150 million ULTGO bonds (dedicated revenues) series 2016B.

The bonds sold via negotiation on July 27th. Proceeds will finance capital improvements, fund capitalized interest and pay the costs of issuance of the bonds.

Fitch has also affirmed the 'B+' rating on the following CBOE obligations:

--Long-Term Issuer Default Rating (IDR);

--Approximately $6.5 billion of outstanding ULTGO bonds.

The Rating Outlook remains Negative.

SECURITY

The bonds are payable in the first instance from unrestricted general state aid and are also general obligations of the CBOE, payable from unlimited ad valorem taxes levied against all taxable property in the city of Chicago.

KEY RATING DRIVERS

The 'B+' rating reflects CPS's chronic structural imbalance, slim reserves and weak liquidity position which are exacerbated by rising long-term liability costs, an acrimonious labor relationship and the lack of an independent ability to raise revenues.

Economic Resource Base

The Chicago Board of Education provides preK-12 education to over 390,000 students within the city of Chicago. Its taxing jurisdiction is coterminous with the city of Chicago. The Chicago Public Schools (CPS) manages the school system which is composed of 673 school facilities. Chicago serves as the economic and cultural center for the Midwestern region of the United States. The city'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. CPS derives about a third of its revenues from the state of Illinois (rated 'BBB+'/Rating Watch Negative). State-wide economic growth through the current expansion has lagged that of the U.S. as a whole.

Revenue Framework: 'bbb' factor assessment

Fitch expects natural revenue growth, absent new revenue action to keep pace with inflation. CPS has no independent legal ability to raise revenues.

Expenditure Framework: 'bbb' factor assessment

Fitch expects the natural pace of expenditure growth to exceed that of revenues, necessitating ongoing budget management. CPS has made significant cuts in recent years, and Fitch believes that the practical ability to cut spending throughout the economic cycle is limited.

Long-Term Liability Burden: 'a' factor assessment

The long-term liability burden is elevated, but still in the moderate range, relative to the resource base.

Operating Performance: '< bb' factor assessment

Financial operations are strained, structurally imbalanced and reliant upon year-round cash flow borrowing. Fitch expects budgetary imbalance to persist despite the district's intention to rein in spending and its expectations that state aid will grow. Reserve levels are narrow despite low expected revenue volatility and given limited budgetary flexibility Fitch believes financial operations are poorly positioned to absorb even a mild economic downturn without further impairing liquidity.

RATING SENSITIVITIES

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.

CREDIT PROFILE

Chicago acts as the economic engine for the Midwestern region of the United States. The city's residents are afforded abundant employment opportunities within this deep and diverse regional economy. The city also benefits from an extensive infrastructure network, including a vast rail system, which supports continued growth. The employment base is represented by all major sectors with concentrations in the wholesale trade, professional and business services and financial sectors. Socioeconomic indicators are mixed as is typical for an urbanized area, with above-average per capita income and educational levels, but also elevated individual poverty rates.

CPS relies on state funding for a significant amount of support. Illinois is a large, wealthy state with a diverse economy centered on the Chicago metropolitan area. The state's operating performance, both during the most recent recession and in this subsequent period of economic growth, has been very weak. The failure to address a long-standing structural budget gap with permanent and comprehensive solutions, whether revenue or expenditure, has left the state with a gaping hole in its operating budget and increasing budgetary liabilities.

Revenue Framework

Property taxes provided 46% and state aid 32% of general fund revenues in fiscal 2015.

Growth prospects for revenues are slow, without taking into account potential revenue-raising measures. Actual revenues are budgeted to rise significantly in fiscal 2017 as the result of both local and state policy action. The city of Chicago approved a $250 million increase in property taxes (equivalent to 4.5% of general fund spending) beginning in fiscal 2017 to be used for pension payments. State aid is budgeted to rise by $317 million including $102 million in state poverty grants. The remaining $215 million represents a state pension contribution which has not yet received state approval. This represents a fairly large budgetary vulnerability as the governor has stated that his support is contingent upon the passage of a comprehensive pension reform plan.

Independent legal ability to raise revenues is limited, like many school districts in the U.S. Annual growth in the property tax levy is limited by the Property Tax Extension Limitation Law to the lesser of 5% or the rate of inflation.

Expenditure Framework

The district devoted 50% of fiscal 2015 governmental fund spending to instruction, 15% to general support services, 10% to pensions, 8% to debt service and 6% to capital outlay.

Fitch expects the natural pace of spending growth to be above natural revenue growth, given rising pension contributions and uncertain labor costs. Management has actively managed expenditure growth, with a series of substantial cuts over the past several years including administrative cutbacks, school closures and layoffs. Labor contracts, which had kept labor costs relatively flat, are currently expired. Management has proposed modest wage increases in return for a reduction in the pension pickup, whereby CPS pays 7% of the 9% employee portion of the pension payment. The teachers' union has rejected this offer and threatened to strike in the near term, rendering the future labor cost trajectory uncertain.

CPS' practical ability to make future expenditure cuts is limited. While politically difficult, such cuts could include those for efficiency, programs, and labor costs. Further cuts may become necessary, particularly if the entire amount of budgeted state aid is not realized. These may be complicated by the district's acrimonious relationship with its labor unions, which have a history of striking.

Carrying costs for debt service and actuarially-determined pension contributions are currently moderate at 19.2% of governmental spending in fiscal 2015; however, increasing pension and debt service costs will likely raise carrying costs to elevated levels over the next several years.

Long-Term Liability Burden

The long-term liability burden is elevated but still moderate relative to the resource base. The net pension liability plus overall debt represents 25.1% of personal income. Overlapping debt accounts for almost half of the long-term liability burden, with net pension liability representing a third and direct debt approximately 20%. Amortization of direct debt is slow with 25% of debt scheduled for retirement in ten years. Fitch anticipates that while the net pension liability should remain relatively stable, increased direct and overlapping borrowing may drive that ratio higher, although it should remain solidly within the 'a' category.

Pension benefits for teachers are provided through the Public School Teachers' Pension and Retirement Fund of Chicago (CTPF), a cost-sharing multi-employer defined benefit plan in which CPS is the major contributor. Under GASB 68 reporting, the plan reported a 51.6% asset to liability ratio as of June 30, 2015. Fitch estimates the ratio to be slightly lower at 47.7% when adjusted to reflect a 7% return assumption. The weak ratios stem from several years of pension payment holidays and poor investment returns. The district dramatically increased pension funding in fiscal 2014 to comply with a state law requiring payments sufficient to reach a 90% funding level by 2059.

Pension benefits for other personnel are provided through the Municipal Employees' Annuity and Benefit Fund of Chicago (MEABF), a cost-sharing multi-employer defined benefit plan, whose major contributor is the city of Chicago. The MEABF plan also has weak asset to liability ratio of 20.3%. CPS does not directly contribute to the plan and its proportionate share of the net pension liability is $0.

Other post-employment benefits (OPEB) are similarly underfunded but annual payments are statutorily capped at $65 million.

Operating Performance

Financial resilience is the key credit concern, as CPS's narrow and declining reserves provide insufficient cushion against a potential revenue stress. Unrestricted general fund balance was 4.5% of spending in fiscal 2015. The fiscal 2016 budget included a $185 million appropriation of general fund balance, but preliminary fiscal 2016 results show a larger draw of $367 million. The negative budgetary variance was largely due to a $480 million state aid payment for pensions that was budgeted but not realized. The fiscal 2017 budget includes an additional $81 million use of fund balance which will bring reserves close to zero. The lack of an adequate financial cushion leaves CPS ill-prepared to withstand even a moderate economic downturn.

CPS still struggles with structural budgetary balance which is concerning this far into an economic recovery. Much of the imbalance stems from the shift in fiscal 2014 from statutory to actuarially-based pension payments, which presented a dramatic rise in spending without a corresponding revenue increase. Recent budgets have also relied upon unsustainable practices including appropriated reserves, scoop and toss restructurings for budgetary relief and optimistic budgeting of revenues. The fiscal 2017 budget represents a measure of improvement, incorporating a mixture of expenditure controls and increased revenues; however, budgeted expenditures still exceed revenues by $81 million and receipt of the budgeted $215 million state payment for pensions remains speculative.

Liquidity is extremely weak, with 12 days of cash on hand at the end of fiscal 2015. CPS' cash position declined dramatically from $1.1 billion 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 were subsequently reimbursed by issuance of long-term bonds and the acceleration of vendor payments that were partially reimbursed in fiscal 2015.

CPS remains highly dependent upon market access for short-term borrowing. The district's reliance on external sources of liquidity is increasing. Cash flow borrowing will rise from $1.065 billion in fiscal 2016 to $1.55 billion in fiscal 2017. The district's cash flow forecast for fiscal 2017 shows no point during the year when cash is positive net of cash flow borrowing; however, the district reports positive cash position for most of the month of August 2016. While the cash flow forecasts include the $1.55 billion of borrowing, these lines of credit have not yet been finalized.

Additional information is available at 'www.fitchratings.com'.

In addition to the sources of information identified in the applicable criteria specified below, this action was informed by information from Lumesis and InvestorTools.

Applicable Criteria

U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)

https://www.fitchratings.com/site/re/879478

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Fitch Ratings
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