Lawsuit Paints Grim Financial Picture for Chicago Schools

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CHICAGO – With its short-term borrowing capacity tied up by a looming pension payment, Chicago Public Schools is warning that without state help or court intervention a $129 million shortfall may force it to end the school year early.

The district sounded the alarm in court filings Monday.

CPS is asking the court to issue an injunction halting the state's distribution of aid based on formulas it alleges discriminate against its students and it wants the request considered in an expedited manner.

The filings paint a dire picture of the junk-rated district's precarious finances and heavy reliance on short-term borrowing just to stay afloat.

They also intensify the district's feud with the state over funding, sparked by Gov. Bruce Rauner's veto of $215 million in help covering its teachers' pension payment due in late June.

"Governor Rauner's veto has created a gap CPS cannot fill through additional borrowings," filings said.

"What we are saying is that we have few options left, either more difficult and painful cuts or a shorter school year," CPS Chief Executive Officer Forrest Claypool said at a news conference Monday to discuss the filings.

"Ending school early is our worst case scenario," he said. "I want to be crystal clear we believe that it is possible to avoid ending the school year early but only if Springfield acts or if Judge Valderrama enjoins the state from distributing funding in a racially discriminatory matter."

The district's latest warning carries pros and cons for investors, said Matt Fabian, partner at Municipal Market Analytics.

"I think it's a very short term positive for bondholders in that it shows a willingness to cut what are the most fundamental expenses the school district has," Fabian said. "On the other hand, it will heighten political volatility by creating local enemies, and that's never a good thing for a credit."

The Chicago Board of Education filed a complaint against Illinois on Feb. 14 alleging that its funding formulas discriminate against the district's mostly minority student population. The district contends that it would receive $500 million more under a fair system.

The request for an injunction to block the state's distribution of funds under current formulas the district filed Monday will receive an initial hearing Friday before Cook County Circuit Court Judge Franklin Ulyses Valderrama, according to CPS.

The district wants the court to expedite its consideration and act by the week of April 24 so it has time to decide on a shortened school year if needed.

"Long ago, CPS ran out of good options. The next round of cuts almost certainly will require CPS to cut even more days from this year's school calendar - ending as early as June 1, 2017," the filings said. The district previously ordered four furlough days.

The next round of cuts also is likely to require the cancellation of summer school for grade school and middle school students. While achieving budget savings, it was not immediately clear how trimming days from the calendar might impact CPS' state funding levels.

Trimming so many days would violate state requirements on school days, so it could lose as much as $45 million in aid in the next fiscal year, according to some estimates. While a waiver could be sought, it’s unclear whether it’s too late to apply for one and legislative approval would be needed to avoid penalties.

The district still has a $129 million budget hole from the $215 million gap left by Rauner's December veto.

The bill he vetoed was tied to passage of state pension reforms that never came to pass.

The aid was part of a stopgap state budget package approved last June due to the prolonged state budget impasse. The district also received $130 million in additional poverty grants as part of the education appropriation.

After passing a revised $5.4 billion budget last week for fiscal 2017 that reflected a fresh round of cuts, the district then rescinded $18 million of local school budget reductions due to intense public pressure, pushing a $111 million gap back to $129 million.

CPS could save $91 million by ending classes June 1 instead of June 20 as scheduled, with another $5 million saved by canceling some summer school.

The Rauner administration responded to the filings by suggesting the district's efforts should be focused on helping win passage of a state budget fix. The administration's tone has softened from recent statements admonishing the cuts.

"As children statewide continue to be impacted by the state's broken school funding formula, now is the time for CEO Claypool to engage in a constructive process to pass a balanced budget with changes that would help schools across the state, including those in Chicago," Illinois Secretary of Education Beth Purvis said in a statement.

Borrowing isn't an option because the district needs its remaining short-term authority just to stay afloat and to make its next pension payment.

"CPS has been working on additional borrowings to address its cash flow. Even if the state had followed through and committed $215 million to CPS pension funding, CPS still would require hundreds of millions of additional borrowings to meet its cash flow obligations," filings said.

"To be clear, even with additional budget cuts to fill the $215 million hole, CPS still must access the capital markets to borrow hundreds of millions of dollars to make its June 30 pension payment - $721 million - to the Chicago Teachers' Pension Fund," the filings said.

The district borrowed $200 million to make its fiscal 2016 teachers' payment last June. The district tapped $1 billion in short-term credit lines in fiscal 2016, paying a punishing rate of 3.25%. Interest on the borrowing added $24 million in costs.

The board raised the short-term borrowing authorization to $1.5 billion for the current fiscal year that runs through June 30.

The district tapped credit lines through tax anticipation note issuance for $325 million in September, $150 million in October, and $475 million in November. They mature Dec. 15 and carry coupons of more than 4%.

"In Fiscal Year 2017, CPS planned to rely upon a combination of new tax revenue from the state, new tax revenue from the city of Chicago, and additional massive borrowings in the capital markets," the district acknowledges in the filings.

The CPS budget benefited this year from the district raising its property tax levy by the maximum amount under state caps, revenue from a new $250 million tax levy for pensions approved last year by the state, and a $45 million capital improvement tax levy approved by the city council.

The lawsuit does not ask the court to force the state to put more money toward education, just allocate it in a "non-discriminatory matter" that CPS believes would improve its position.

That's because the state currently funds most school districts' contributions to the state-run Teachers Retirement System at a cost of $4 billion while it receives only $12 million to cover its contribution to a separate city teachers' fund. The state has countered that CPS has long received more grant funding to offset the lack of pension help.

The district also receives 15% of aid while educating 20% of the state's public school children. CPS gets $1.7 billion annually while $9.6 billion goes to all other districts. The suit was filed Feb. 14 in the Chancery Division of the Cook County Circuit Court alleging violations of the Illinois Civil Rights Act of 2003.

The bipartisan Senate budget fix known as the "Grand Bargain" would restore the $215 million, and the package also includes a bill overhauling school funding, but its language is still being crafted. A vote on the package that would end a 20-month-old budget standoff could come mid-week but its fate in the House and on Rauner's desk is uncertain.

CPS closed the books on fiscal 2016 with an operating deficit of $537 million, has drained most reserves, and tapped out its ability to continue pushing off principal debt repayment.

CPS' GOs are rated junk by Fitch Ratings, Moody's Investors Service, and S&P Global Ratings while Kroll Bond Rating Agency rates the district's GOs in the triple-B category.

On long term bonding, the district struggled with market access early last year and was forced to scale back a planned borrowing, ultimately paying 8.5% tax-exempt interest. The district then delayed a second GO sale planned in late 2016.

In December, it returned with a new security that offered a revenue-backed credit supported by the city council approved capital improvement property tax levy.

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