CHICAGO – Junk-rated Chicago Public Schools’ prospects for an upgrade have improved thanks to its 2017 state funding gains and the state’s recent release of aid based on the new funding formulas, says S&P Global Ratings.
S&P held CPS’ general obligation bonds steady at the B level, so CPS faces a long climb – five notches – to return to an investment grade. S&P revised its outlook to positive from stable in a report Monday. It previously had raised the outlook to stable from negative in October.
"The revised outlook reflects the additional evidence of the board's higher state aid revenue as a result of Illinois' new evidence-based funding formula, which improved the district's financial outlook – building on notable wins for the board in 2017," said analyst Blake Yocom.
The district has diversified the number of tax anticipation note purchasers, important because it relies heavily on costly short-term borrowing to manage cash flow, S&P said. The district’s cash position has improved in its latest March forecast compared to last fall and it’s lowered its short-term borrowing slated for fiscal 2018 by $455 million from $1.55 billion last year. Operations potentially leave CPS with a positive fund balance this year, S&P said.
The improved cash position came at the expense of added borrowing costs as the district last year covered some near-term debt service with new debt. It also reimbursed itself for some swap termination payments.
"A higher rating is currently precluded given a cash flow that is mostly negative through fiscal 2018 and continued uncertainty on the timing of state revenue and if the state will fully fund the new formula," Yocom said.
Further improvements in cash flow and ongoing evidence of the state’s support for the higher funding formulas approved last August could drive an upgrade. The rating agency also would view positively a further reduction in TAN borrowing and improved structural balance.
The district faces challenges making further strides due to high fixed costs, large unfunded pension liabilities, and looming contract negotiations, S&P said.
The district’s 2017 gains included $220 million in new state funding to cover a portion of its pension contributions, $100 million in additional general aid, and $130 in a special state-approved property tax levy for pension payments. Chicago also agreed to provide $80 million for security costs.
Mayor Rahm Emanuel promoted the outlook change in a statement.
“Seven years ago, we inherited a school district with shaky finances that struggled with legacy pension costs and today Chicago Public Schools is on much stronger financial ground because of our collective efforts," he said, "especially working with the General Assembly to pass historic school funding reform.”
While its structural woes were growing seven years ago, the district carried healthy ratings of A-plus from Fitch Ratings, a Aa3 from Moody’s Investors Service, and an AA-minus from S&P in 2011. The next year each agency dropped them one to two notches.
The district now is rated BB-minus with a stable outlook by Fitch and B3 by Moody’s with a stable outlook. Its GOs carry one investment grade rating: BBB and BBB-minus on various issues from Kroll Bond Rating Agency, with a positive outlook.
“CPS still remains challenged with severe financial problems due to its reliance on short-term borrowing, its long-term debt burden and increasing pension costs,” the Chicago Civic Federation warned in a recent review of CPS’ financial health.
The district has $8.3 billion of long-term general obligation and capital improvement tax-backed bonds. Its short-term borrowing remains costly with $79 million budgeted in fiscal 2018 for interest although that could be cut based on now lower estimated borrowing levels.
CPS’ pension contribution this year totals $784 million. Future increases are likely as the district is carrying $10.9 billion of unfunded liabilities and faces a state mandate to reach a 90% funded ratio from its current 50.1% level by 2059.
The fund’s recent moves – at the recommendation of the state actuary – to lower its investment return estimate to 7.25% from 7.75% and changes in other actuarial assumptions added more than $1 billion to the fiscal 2017 unfunded liabilities. The funded ratio declined to 50.1% from 52.5%.
The Board of Education in March approved the refunding of up to $600 million of GOs. The district pays a steep penalty to borrow but the summer funding boost buoyed market perception and the district in its sale late last year shaved more than 200 basis points off spreads from a sale earlier in the year.
Spreads late last year initially ranged from 230 to 260 basis points above the Municipal Market Data top-rated benchmark before they were repriced by 5 to 20 bp better. That compared to a roughly 480bp spread seen earlier in the year. CPS GOs don’t trade frequently, but a 2042 maturity traded recently at a 233 basis point spread, Dan Berger, MMD municipal strategist, said Monday.
A 2044 maturity traded at even better spread this week of 213.9 basis points.
CPS released its local school budgets Tuesday. Schools will receive $3.1 billion in fiscal 2019, up $60 million from the current fiscal year that runs through June 30. CPS operates on a nearly $6 billion annual budget.
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Updated April 17, 2018 at 4:49PM: The story was updated with more recent secondary pricing information.