CHICAGO – The headwinds for Chicago Public Schools intensified as the system prepared to sell bonds next week, as one of its ratings sank deeper into junk territory and the state's minority Republican leaders mounted a takeover effort backed by Gov. Bruce Rauner.
Fitch Ratings Wednesday socked the Chicago Board of Education's credit with a three-notch downgrade, dropping its rating on $6.1 billion of debt and its planned $875 million general obligation issue to B-plus from BB-plus. That leaves it at the same ratings level as Moody's Investors Service and Standard & Poor's.
The board plans to sell $795 million of tax-exempt securities and $89 million of taxable paper late next week. JPMorgan is running the books and Barclays is a co-senior manager.
Moody's, which is no longer asked to rate CPS' new issues, has the credit under review for a downgrade. Standard & Poor's lowered its rating last week two notches and has it on watch with negative implications. Fitch assigned a negative outlook. Kroll Bond Rating Agency late Tuesday assigned a BBB and negative outlook to the new bond issue based on legal reviews of the structure.
The fresh credit blow underscores the severity of the near-term stress CPS faces as its pleas for an additional $480 million in state pension help to balance its current $5.6 billion budget go unanswered. Without its short-term credit lines the district would run out of cash to pay its bills and keep schools open.
The district also faces a $1 billion deficit in its next budget as it's relied on one-time maneuvers like debt restructuring, reserve use, and a partial pension holiday to paper over operations in recent years. District leaders, who have warned of layoffs that will hurt academic strides if they don't get fiscal help, face the threat of a teachers strike as CPS chief executive officer pushes teachers to make fiscal concessions in contract negotiations.
"The downgrade reflects the limited progress Chicago Public Schools has made in addressing a structural budget gap approximating 20% of spending for the current fiscal year," Fitch wrote. "Following substantial drawdowns in fiscal years 2013-2015, reserves will likely be fully depleted by the end of fiscal 2017."
Fitch considers a rating at the single B level to be "highly speculative" compared to a "speculative" label on a BB rating. The single B indicates "that material default risk is present, but a limited margin of safety remains. Financial commitments are currently being met; however, capacity for continued payment is vulnerable to deterioration in the business and economic environment," Fitch said.
CPS' request for help from leaders at the capital is caught in the state's own political quagmire. Gov. Bruce Rauner has offered some forms of greater fiscal assistance, but only if Chicago Mayor Rahm Emanuel expends his own political capital to push Rauner's turnaround agenda with the General Assembly's Democratic leadership. Their opposition to the GOP governor's worker's compensation and tort reforms, term limits, and local government union curbs have driven a seven-month-old impasse on adoption of a fiscal 2016 budget.
GOP leaders – backed by Rauner – added to the district's headline risk Wednesday in announcing legislation that would extend existing statutes allowing for a state takeover of troubled districts to include CPS.
One market participant said the legislation may be dead on arrival given Democratic control, but it still poses negative headline risks and is a distraction from efforts to arrive at some compromise that could help the district.
The GOP proposal would allow the State Board of Education to strip control of the district from the Chicago Board of Education, whose members are appointed by Mayor Rahm Emanuel, with the state superintendent appointing independent members of a special oversight board.
Separate legislation expected soon would provide a path for the district to seek a restructuring under Chapter 9, which is not currently permitted under existing state statutes, if oversight doesn't resolve the district's fiscal woes. Eventually, an elected board would run CPS.
The legislative sponsors labeled the takeover a "lifeline" that won't offer a bailout, so it doesn't appear that the legislation offers any near-term help to avert a CPS fiscal collapse.
"We are throwing Chicago and CPS a lifeline," said House minority leader Rep. Jim Durkin. "The Chicago Public Schools are facing massive layoffs and a possible teachers' strike and despite credit downgrades to junk status CPS is now looking to long term bonds to pay for hundreds of millions of dollars in short term operating expenses."
The state would not be responsible for CPS debts under a takeover. "This is not a bailout," Durkin said at a news conference with co-sponsor Senate Minority Leader Christine Radogno.
Durkin said the city and CPS both face a fiscal crisis that could have been averted and both are due in part to their pension tabs. The bankruptcy legislation would allow both to pursue a Chapter 9. "The goal here is to provide the tools to right the ship," he said. Chicago Public Schools has $9 billion of unfunded liabilities and Chicago is saddled with $20 billion.
The proposals were slammed by Emanuel, Democratic legislative leaders, CPS, and the Chicago Teacher's Union. Critics view the move as another attempt by Rauner to curb union powers, as the bankruptcy provision would allow CPS to restructure employee benefits and to pressure Democrats to support his turnaround agenda as a means to avert a CPS collapse. Rauner has backed legislation that would establish a Chapter 9 statute for local units of governments, but it's gone nowhere with Democratic leaders.
"This is not going to happen. It's mean spirited and evidence of their total lack of knowledge of the real problems facing Chicago Public Schools," Senate President John Cullerton said in a statement. "This ridiculous idea only serves as a distraction from the state's problems that these two state leaders should be focusing on."
Schools' chief Forrest Claypool went on the attack. "Instead of offering a reckless smokescreen that distracts from the real financial problems facing CPS, the governor should pass a state budget that treats CPS students equally with the rest of the state," he said.
Backers acknowledged the opposition of Democratic leaders, but suggested some downstate Democrats might be more open to the proposals. "I think there is definitely a crisis in confidence in the leadership" of Chicago, Radogno said.
When asked about Democratic opposition, Durkin said "it is to their peril" for lawmakers to maintain the "status quo." Democrats enjoy a super majority in both chambers.
An oversight panel wouldn't be empowered to break any existing contract, although it would have power to negotiate new ones. CPS and the CTU are currently negotiating a new contract. Under Chapter 9, any existing contract could be renegotiated.
The two leaders dispute CPS' assertion of a disparity in general state aid, arguing that an additional $600 million in grant block funds makes up for it. Backers of the takeover plan sought to stress that it simply extends to CPS state oversight that can be imposed on the state's more than 800 districts. Seven districts have come under oversight since 2002.
CPS collapsed financially in the late 1970s, when it was locked out of the market for failing to disclose that a planned issuance would repay outstanding notes, leading to the state's creation of the Chicago School Finance Authority. A consortium of local banks came together to purchase the district's debt and keep it afloat. The state passed reform legislation in the mid-1990s handing control of the district back to then Chicago Mayor Richard Daley.
The Fitch report from primary CPS analyst Arlene Bohner highlights some of the struggles CPS is grappling with that are difficult to fix absent new powers -- which an oversight panel would lack without additional changes in state law. The district has a relatively inflexible expenditure profile and little to no independent ability to raise revenues as it bumps up against property tax caps.
"Substantial changes are necessary to support ongoing operating and fixed cost spending," analysts said. "Most options for relief are dependent on actions by the state, which is plagued by political disagreements and its own challenged financial position."
Fitch said it's monitoring access to external liquidity as the district relies more heavily on short term borrowing to finance on-going operations. The district anticipates a narrow $33 million when it closes the books June 30 after making a $675 million pension payment. The ending balance projection assumes no additional state help is forthcoming and the use of short term lines.
The city's economic strength is a key credit strength and the district's reduction in its floating-rate exposure to 13.5% from 40% in recent years is a positive.
The district's issue is secured by its general obligation, unlimited tax pledge which serves as the backup to the primary pledge of unrestricted general state aid. "Fitch believes that the mechanics of the GSA pledge do not insulate bondholders from the issuer's general credit," analysts wrote.
About $393 million of the bond proceeds will fund capital projects; $135 million will refund variable-rate debt that is being shifted to a fixed rate; $86 million will retire short-term debt used to cover swap termination payments; and $206 million represents a scoop-and-toss restructuring in which the district borrows to pay off maturing bonds. The rest will cover capitalized interest and issuance costs.
Democratic House Speaker Michael Madigan also fired back. "Seven months into a new fiscal year, the state still has no budget under Republican Gov. Bruce Rauner, and it's because he's more interested in driving down the wages and standard of living of middle-class families than working together to solve our state's problems," Madigan said in a statement. "Gov. Rauner hopes to use a crisis to impose his anti-middle class agenda. Republicans' ultimate plans include allowing cities throughout the state to file for bankruptcy protection."
