Fitch Ratings Monday became the second rating agency to drop Chicago Public Schools to junk.

CHICAGO— The Chicago Public Schools lost another investment grade rating Monday when Fitch Ratings downgraded the district to BB-plus and warned it might not stop there.

Fitch's action, punishing the district for its growing structural budget gaps and heavy use of reserves and borrowing to remain afloat, followed Moody's Investors Service's three-notch May downgrade to Ba3.

After lowering the rating to BB-plus from BBB-minus, Fitch put the Chicago Board of Education's $6 billion of debt on negative watch, signaling further downgrades could be in store as the district works to close a $1.1 billion gap in its fiscal 2016 budget that will be released this month.

"The downgrade reflects the limited progress the Chicago Public Schools has made in addressing a structural budget gap approximating 20% of spending for the current fiscal year. Following substantial drawdowns in fiscal years 2013-2015, reserves will likely be fully depleted by the end of fiscal 2016," Fitch analysts wrote.

"The district is highly dependent on borrowing in the upcoming months to finance on-going operations, so Fitch will be monitoring access to external financing," they wrote. "Substantial changes are necessary to support ongoing operating and fixed cost spending. Options within the board's sole control are limited and Fitch believes meaningful solutions with other parties over the next several months will be a determining factor in the rating."

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" and 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.

CPS said the downgrade only underscores the severity of the district's need for state help. "As Fitch points out, CPS has limited options for addressing our $1.1 billion shortfall, which makes it even more critical to reach a comprehensive budget solution with our partners in Springfield. Our priority will continue to be working toward that broad solution so that we don't have to make even deeper reductions or undertake more unsustainable borrowing," CPS chief financial officer Ginger Ostro said in a statement.

The action follows the district's disclosure last week that it may borrow more than $1 billion in the coming months with between $600 million and $650 million going for capital projects already underway; another $250 million to $300 million to convert floating-rate paper to a fixed-rate and cover the negative valuation on swaps; and $150 million to $250 million used for scoop-and-toss debt restructuring for budget relief.

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.

In addition to its growing unfunded pension tab now at $10 billion, the district's heavy reliance on one-shot actions like debt restructuring and reserve use have helped drag down its ratings that were once in the double-A category. A prior downgrade by both Fitch and Moody's to below the BBB threshold triggered the swap termination event that is forcing the district to deal with swap termination triggers.

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.

While Gov. Bruce Rauner has floated bankruptcy as an option for the district, the state has no such statute allowing it to file and Chicago Mayor Rahm Emanuel and his new pick for the district's chief executive officer, Forrest Claypool, have said they are against such a move.

Fitch highlights in its review the strains on the district's liquidity level which have "been greatly diminished, requiring increasing levels of short-term borrowing." The district tapped credit lines to make a more than $600 payment to its teacher's fund for fiscal 2015 late last month and that debt must be repaid by October.

The district's proposed solutions for its budget woes rely primarily on the state government with some help from the city. The district wants about $200 million in state help to cover a $700 million teachers' fund payment in the fiscal year that began July 1 and wants teachers to cover a bigger share of the contribution. Emanuel has said with those options in hand, he would push for a special property tax hike.

The district plans to include savings of $500 million from state help in its budget which Fitch sees as problematic.

"Most options for relief are dependent on actions by the state, which is plagued by political disagreements and its own challenged financial position," analysts wrote.

The district's debt levels are above average with slow amortization, and its teachers' contract has expired. A potential strike this September looms, adding to the system's woes.

The district lacks the same flexibility the city or county have to raise taxes as it falls under property tax caps and its general fund reserves are down to about $159 million.

"The district has tried to avoid cuts that would impact the classroom, but such cuts are growing increasingly likely," Fitch wrote.

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



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