Chicago teacher contract will matter to rating agencies

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Chicago Public Schools’ long road back to investment-grade ratings could get a lot harder.

That path depends on the final price tag for the teachers’ contract that’s being negotiated amid a strike.

While the strike itself is unlikely to materially impact CPS’ junk rating, the final contract’s terms are “crucial to credit quality,” Moody’s Investors Service said in a special commentary published after the walkout began Thursday. Moody’s rates the district B2 with a stable outlook.

“The outcome of the labor negotiations will have substantial ramifications on whether CPS' financial recovery continues, given the district's limited financial flexibility and narrow reserves. CPS will, however, avoid material credit effects during the two union strikes, assuming the work stoppages are reasonably short,” Moody’s said.

In the near-term, operating revenue shouldn’t be impacted. The flow of state aid, which accounts for 34% of CPS funding, is based on enrollment. Property taxes, CPS' largest revenue source at 44%, are not impacted by the strike. The board of education posted a supplement to its $250 million note sale set for Tuesday, notifying investors of the strike.

Illinois school districts are required to ensure 176 days of instruction. Illinois State Board of Education representatives have indicated that the district would likely not lose funding should the threshold be missed. Mayor Lori Lightfoot and schools chief Janice Jackson reiterated their position Thursday that days won’t be made up but that could change if aid was threatened.

The contract’s cost will add to the fixed costs of the district. CPS has limited financial flexibility with labor costs that account for 37% of its expenses with other compensation accounting for 6%, pensions accounting for 16%, debt service 10%, and “other” expenses making up the remainder.

The CTU is seeking, among other items, salary increases, reduced class sizes, and affordable housing. CPS officials say the staffing increases would cost $800 million over a three-year period. CPS’ fiscal 2020 budget allocated $330 million for “contingencies,” Moody’s said.

Lightfoot warned Thursday that the price tag is $2.5 billion for all measures the Chicago Teachers Union is seeking.

“While a portion is available for adding additional staff in the current school year, the amount is unlikely to be sufficient to meet all union demands. In addition, CPS' fund balance provides very limited cushion with the district estimating a general fund balance at fiscal year-end 2019 of only $365 million or 5% of fiscal 2019 general fund revenue,” Moody’s said.

The district won two upgrades ahead of a September general obligation sale: to BB from BB-minus from Fitch Ratings, with a stable outlook, and to BB-minus from B-plus from S&P, which assigned a positive outlook.

Fitch said it’s watching for the final price tag. The district is in somewhat better positioned to withstand the labor action than the last time the teachers’ union struck in 2012 because additional state aid and local property taxes helped cut a $1 billion deficit and allowed the district to begin rebuilding reserves, said Fitch analyst Arlene Bohner.

“A prolonged strike could become quite costly. As with any labor action, we are watching to see if the ultimate settlement will be affordable for the district and if it will crowd out other spending priorities,” Bohner said. “If the final resolution causes the district to materially deplete its reserves or leaves it with an unsustainable cost structure, credit quality could be affected.

“Notably, the teachers’ union has raised some issues not typically seen in a labor negotiations, including affordable housing assistance,” Bohner said, adding that Fitch would be issuing a report on emerging trends in contract negotiations.

S&P Global Ratings noted the potential impact of the final contract’s cost in its report upgrading the district ahead of a September sale.

“We may have additional comment should the strike be prolonged. Specifically, if the prolonged strike results in a reduction in state aid and any potential concessions create a structural gap with no plan to close,” said analyst Blake Yocom.

Kroll Bond Rating Agency is the sole agency to rate CPS GOs at investment grade with BBB and BBB-minus ratings, depending on the series, with a positive outlook. Kroll said Thursday it would comment once a deal is done.

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