Fitch Ratings downgraded the Philadelphia School District’s underlying rating to BB from BBB-minus, while keeping the enhanced rating at AA-minus.

The outlook on both ratings is negative.

The rating change affects $2.1 billion in district general obligation bonds and $1.1 billion in Pennsylvania Public School Building Authority school lease revenue bonds.

The downgrade reflects the weakening of the district’s financial position, said Fitch director Eric Friedman.

In fiscal 2012 the state cut $200 million in funding for the district.

The following year,  the district had a $250 million cash basis operating deficit. This was covered through the sale of deficit bonds.

Friedman questioned whether the district will be able to achieve structural balance through its teachers accepting salary cuts. “Fitch believes the district will be hard-pressed to achieve the level of savings it has projected,” Friedman said.

Cuts to teacher salaries are not assumed in the fiscal 2014 budget but are part of the district’s five-year plan.

Based on Philadelphia’s recently revised property assessment, the district’s debt ratio is a high 6.5% of market value.

Finally, state revenues provide 57% of the district’s funding and even locally generated revenue changes require state and city council approval. These mechanisms limit the district’s ability to raise revenue. Friedman said.

The enhanced rating is based on the district’s participation in the Pennsylvania State Aid Intercept Program. In the version of the program for the GO debt, if the school district did not make an interest or principal payment when due, the state would withhold the district’s state aid and use the money to pay the paying agent. There are debt service sinking funds to make payments in the short-term.

In the version of the program relevant to the authority debt, the state treasurer diverts the district’s state aid to make payments to the bond trustee.

Moody’s Investors Service downgraded the district’s underlying rating to Ba2 in late July. It maintained the district’s enhanced rating at Aa3.

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