Chicago Schools' Budget Relies on State Help, One-Shots

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CHICAGO — Chicago Public Schools released a proposed $6.4 billion fiscal 2016 budget that pockets more than $300 million from one-time revenues and gambles heavily on the state coming through with nearly $500 million in pension help this year to close a $1.1 billion deficit.

The measures aren't expected to sit well with rating agencies, two of which have knocked the district's credit down to junk, or with investors, who already demand yield penalties on CPS borrowing of as much as 320 basis points over Triple-A munis as the districts fiscal woes have deepened.

"This budget reflects the reality of where we are today — facing a squeeze from both ends — in which CPS is receiving less state funding to pay our bills even as our pension obligations swell to nearly $700 million this year," newly appointed chief executive officer Forrest Claypool said.

The pension funding system has driven CPS to the "breaking point," he added.

The district released its budget late this year as it grappled with how to close the gap and pressed for a partial fix from state lawmakers. While Gov. Bruce Rauner and lawmakers have offered up various proposals that would provide the aid being sought, they've yet to bridge a political divide that has stalled passage of a state budget or finalized any pension help for CPS or Chicago whether through greater aid or changes in payment schedules.

The proposed budget relies on $480 million in state help through some combination of measures that include the state picking up about $200 million in CPS pension contributions that would bring it in line with what the state contributes on behalf of other districts. The district's payment totals $688 million in fiscal 2016 with the state now slated to provide only $12 million. CPS' share rises to $696 million in 2017.

"Most options for relief are dependent on actions by the state, which is plagued by political disagreements and its own challenged financial position," Fitch Ratings said in cutting the district's rating last month.

The package could also be made up by shifting $170 million of the teachers' contribution now paid by the district over to teachers, extending a payment amortization period, and possibly higher property taxes.

The GOP governor tied his support of CPS to Chicago Mayor Rahm Emanuel's support for a larger package that would include pension reforms, a temporary property tax, and collective bargaining curbs for local governments. Emanuel and the General Assembly's Democratic majority oppose the curbs.

The overall $6.4 billion budget cuts the operating plan by $69 million from fiscal 2015 to $5.69 billion. The remainder is made up of a $178 million capital budget, down $288 million from fiscal 2015, and $539 for debt service, down by $65 million.

CPS faces limited revenue flexibility as it bumps up against state imposed tax caps and its pension payments are dictated by a formula set in law, so officials turned to what they can tinker with in the area of operations, debt service, and capital spending.

The gap is further closed with $200 million of cuts announced last month after the district failed in its efforts to delay its fiscal 2015 pension payment.

The budget also relies on $250 million of debt restructuring primarily from so-called scoop and toss refunding in which principal payments coming due are pushed off. The district has relied heavily on the practice to balance recent budgets. The district will draw $75 million from reserves, which were nearly drained to balance past budgets. General fund reserves have dropped to about $159 million. Both fall into the category of non-recurring revenues that contribute to structural budget woes and have contributed to CPS' credit decline.

Another $62 million would come from tax-increment financing surplus revenues. The district has been getting such surplus revenues, though the annual size varies. Another $80 million would come from property tax revenue, including $19 million from raising taxes with the remainder flowing in from new property and taxes coming in earlier than previously expected, according to CPS chief financial officer Ginger Ostro.

The capital budget marks the lowest amount earmarked for infrastructure since 1996 after the state handed control of the district back to the city's mayor, Ostro said. About $115 million will come from CPS funds and the remainder from other sources with the lean spending focused on emergency maintenance and repairs and previously announced projects.

The debt restructuring reduces the amount of state aid the district must divert to cover debt service, but without the state pension help deeper cuts and "further unstainable borrowing" would be needed to balance the books, Ostro said.

The district said it would manage cash flow by tapping a $935 million board-authorized credit line. The district does not appear to have all the bank support needed for the full amount. "We are continuing to work to secure the lines of credit that will help manage cash flow," Ostro said during a conference call with the media.

The district tapped its existing $500 million line and a new $200 million line at the end of June to cover more than $600 million owed to its teacher's pension fund. It must repay that borrowing in October.

Ostro said the district also is continuing negotiations with its interest-rate swap counterparties. Banks could demand more than $200 million in termination payments triggered by downgrades from two rating agencies — Fitch and Moody's Investors Service — to below a BBB/Baa2 level. Both have since dropped the district's $6 billion of debt into junk territory.

Fitch late last month dropped the district to BB-plus and has it on negative watch. That followed Moody's move in May dropping it to Ba3 with a negative outlook.

Fitch said it will watch closely to see whether the district maintains its ability to borrow and use credit lines, which is "important to long-term stability," A downgrade looms if "clear and meaningful progress" is not made over the next several months to reduce its structural imbalance or its debt levels or unfunded pension obligations of $10 billion notably rise, Fitch said.

The board has given initial approval to new borrowing of $1 billion in the coming months, with between $600 million and $650 million going for capital projects already underway and the remainder covering swap terminations and the scoop and toss refunding.

The size of the borrowing plans are somewhat dependent on whether the district gets state pension help. Debt restructuring and borrowing to cover its 2016 pension payment "would result in increased longer-term costs, thus would be considered a negative credit factor by Fitch," analysts wrote.

Standard & Poor's rates the district BBB on CreditWatch negative and Kroll Bond Rating Agency assigns a BBB-plus rating on watch negative.

Chicago schools in recent market appearances paid steep interest rate penalties. The top yield of 5.63% on the board's 25-year maturity in an April sale landed 285 basis points over the Municipal Market Data's triple-A benchmark. Market participants said spreads in recent trades have ranged from 290 to 320 basis points.

The board's bonds carry a GO pledge but most are further secured by an alternate revenue pledge of state aid. That statutory lien doesn't help the ratings although some investors have continued to purchase and hold the securities as courts have looked favorably on such protections in bankruptcy.

Despite the district's rocky fiscal state, Claypool said bankruptcy isn't on the table as CPS pursues state help. Rauner had previously said the district was a good candidate for Chapter 9 if the state added such a provision to its books as he has proposed.

The Chicago Board of Education will vote on the plan later this month. More than 1,400 positions would be cut as part of the previously announced cuts including 479 teachers. They can apply for more 1,400 vacancies.

In addition to CPS' daunting fiscal woes, it faces labor strife as it is at loggerheads with the teachers' union over a new contract and could face a strike this fall. One of the key issues under dispute is the district's push to get teachers to pick up their share of pension contributions now covered by the district. Initially, the two sides were negotiating a one year deal. Now CPS wants a multi-year package.

In other developments that followed CPS' release of the budget, a group of Illinois lawmakers announced a new push to establish an elected school board in Chicago. The current board is appointed by Emanuel. House Bill 4268 would create a 13 member board with members chosen from city voters broken into four regions.

"The city of Chicago has repeatedly blamed the Legislature for failing to take action to improve Chicago Public Schools," said Rep. Rob Martwick, D-Chicago. "No longer will the blame for a failed system of education rest in the hands of a board appointed by the mayor. Instead, citizens of Chicago will have the ability to elect board members to implement the education and financial policies needed to finally turn around CPS."

At his own news conference later on CPS, Rauner called release of the budget "a significant step in the process of acknowledging and accepting the fact that we need major structural reform of our school district and local governments."

Rauner reiterated his pledge to help CPS but again said that it comes with a catch in the form of Chicago's support for legislation that would also free local governments of some collective bargaining requirements and prevailing wage requirements on contracts. He said he was "cautiously optimistic" that CPS and city leaders were beginning to acknowledge the need for statewide reforms.

When asked about the new push for an elected school board that would mirror how other state districts are governed, Rauner said he supports leaving the appointment power with the mayor.

"The power of the teachers union has been overwhelming. Chicago has given and given and given. It's created a financial crisis that the Chicago schools face now," Rauner said.

Rauner said he was "cautiously optimistic" that "leaders here in Chicago are beginning to acknowledge the need for structural change and beginning to move in a direction that's consistent with the reforms we've been advocating for many, many months."

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