CHICAGO Following a two-notch downgrade, the Chicago Public Schools dropped Moody’s Investors Service from the list of rating agencies asked to review its upcoming sales of about $550 million in new money and refunding general obligation paper.
Moody’s took the district, which issues bonds through the Chicago Board of Education, down two notches earlier March 6, leaving it on the final investment grade rung at Baa3. It retains a negative outlook.
The bad credit news didn’t stop there as Standard & Poor’s stung the board and its $6 billion of debt with its own two-notch downgrade Wednesday, to A-minus. Standard & Poor’s also assigned a negative outlook.
“Given the challenges facing the board to restore fiscal balance, it is our expectation that the board's operating reserves may continue to substantially fall in subsequent years to a level that will not support a rating in the 'A' category in the absence of substantial growth in state aid or local revenue sources,” Standard & Poor’s analyst John Kenward wrote in an abbreviated report.
The Moody’s downgrade cited a combination of the district’s governance ties to Chicago, which it has downgraded several times, with the school system’s own pressures from rising pension payments and a looming $1.1 billion deficit. The district has limited flexibility to raise revenues due to state property tax caps.
The downgrade followed Moody’s lowering of Chicago’s rating one level to Baa2 and a downgrade of the park district. All share the same tax base.
“The board previously engaged Moody’s Investors Service to assign ratings for prior bond issues. The board has elected not to obtain a rating from Moody’s for the 2015 bonds,” says the offering statement for the new bond issue.
Fitch Ratings has not yet released its updated review. It currently assigns the board a rating of A-minus and negative outlook.
The district is joining several of its sister city agencies hit with steep Moody’s downgrades in asking Kroll Bond Rating Agency for a first-time rating. That review was expected to be published later this week.
All of the debt in the upcoming sales will carry both a general obligation pledge and an alternate revenue pledge of state aid.
The board was initially slated to sell as soon as Thursday two series of floating rate notes although they are now expected to push back the sale slightly as ratings are finalized. They include $89.2 million with a final maturity in 2032 to refund 2000 variable-rate bonds, and an $89 million series to refund 2011 variable-rate bonds.
The new structure allows the district to reduce its bank credit exposure. Swap terms tied to the 2011 bonds will be transferred to the floating rate note issuance.
Later this month, the board will return to the market to price $175.6 million of fixed-rate bonds with a final maturity in 2035, $100 million of new money put bonds with a final maturity in 2039, $20 million of fixed-rate paper designated at green bonds with a final maturity in 2032, and $75.5 million of fixed-rate bonds to refund 2004 bonds for economic savings. The board is also privately placing $4.3 million of qualified zone academy bonds.
The district had previously said that much of the new money would go to pay down its bank held debt in various lines of credit and and/or tax anticipation notes. PNC Bank and BMO Harris Bank hold the existing debt.
The green bonds will finance energy efficiency projects including ones that initially were planned to be completed with financing through the Chicago Infrastructure Trust. The offering statement warns that the district offers no “representation” that all uses will meet green standards.
PNC Capital Markets and BMO Capital Markets are co-senior managers on the financings. Acacia Financial Group Inc. and Public Financial Management Inc. are advising the district. The underwriting syndicate includes another 11 firms. Quarles & Brady LLP and Hardwick Law Firm LLC are bond counsel.
The district sought to highlight in an investor presentation bondholder protections provided by the multiple pledges assigned to the bonds. The general state aid revenue pledge provides strong coverage. The district expects to receive $1 billion from the state aid pledge this year and debt service requirements are deposited annually by Feb. 15 with the trustee.
The district highlighted in its investor presentation the city’s tax base and spending cuts totaling $740 million since 2011 and $40 million in operational savings expected annually through the closure of 50 schools. The controversial closing of the schools approved by Mayor Rahm Emanuel, who names board members and handpicked schools chief executive officer Barbara Byrd-Bennett, is a key campaign issue in the April 7 mayoral runoff election.
Officials have also lowered capital spending estimates to “minimize future debt” expenses with about $155 million to $160 million planned annually through 2018.
The district’s heavy use of non-recurring revenues have contributed heavily to its steep ratings slide.
The district drained $513 million from reserves in fiscal 2014 and $862 million in 2015 to shore up a budget of nearly $6 billion. The district expects to close out fiscal 2015 on June 30 with an ending reserve balance of $227 million. It extended its revenue recognition period last year so it could count more property tax revenue collected over the summer to balance its prior-year books.
CPS will release a fiscal 2016 budget in the coming months, which will have to close an estimated $1.1 billion gap due to rising pension payments and expenses. Its pension contribution rises to $688 million in the next budget, up from $634 million this year. The teachers’ pension fund is saddled with $9.5 billion of unfunded liabilities.
In the investor presentation, chief financial officer Ginger Ostro and debt manager Walter Stock said the district is eyeing further administrative cuts and continues to press state lawmakers for help on pensions and additional general aid and construction funding. With the state government grappling with a $6 billion deficit, the prospects for additional help are uncertain.
If reforms to the state teachers’ pension fund in 2013 were applied to Chicago schools’ teachers fund, the district said it could trim $210 million from its 2016 payment.
Unions and retirees challenged those reforms and the case is before the Illinois Supreme Court.
If reforms proposed by Gov. Bruce Rauner were adopted, the district said it would cut $150 million off the next pension contribution. The prospects for those reform proposals are uncertain.
The district has 10 derivatives on a notional amount of $1.1 billion, including $905 million of synthetic fixed-rate interest swaps and $187 million of basis swaps that combined carried a negative valuation of $215 million as of June 30. Termination events are not triggered until two rating agencies downgrade the board’s rating to a level below the mid-BBB level.
On its line of credit debt, a downgrade by Fitch, Moody’s or Standard & Poor’s would trigger a default event that could result in the district’s tax-exempt interest rate rising to 9% and its taxable rate growing to 13.5%. It does not face any threat of acceleration under its credit terms. Moody’s has warned a failure to structurally balance its budget, further reductions in operating reserves and liquidity, and further deterioration in the city's rating could drive a subsequent downgrade to speculative grade.
