Long-term concerns about whether higher spending Philadelphia plans for its school district will be supported by new tax revenues joined pensions to drive its first downgrade in more than seven years.
S&P Global Ratings cut Philadelphia’s general obligation bond rating to A from A-plus late Friday citing spending challenges associated with supporting its public schools and the city's pension obligations. The outlook is stable at the new rating; 16 months ago S&P revised its outlook for Pennsylvania’s largest city to negative from stable due largely to rising retirement costs.
"The lowered rating reflects our view of the city's likely longer term credit trajectory as it continues to address the costs associated with managing its pension pressures and School District of Philadelphia costs," S&P Global Ratings credit analyst Lisa Schroeer said in a statement. “The stable outlook reflects our view of Philadelphia's improved financial cushion, bolstered by what we view as strong management.”
S&P’s A rating is now on par with Moody’s Investors Service, which rates the city’s GO debt at A2, and a notch above Fitch Ratings’ A-minus mark. Philadelphia’s previous downgrade occurred in November 2010 when Moody’s dropped the city’s bond rating one notch citing weak finances. Fitch’s last Philadelphia downgrade was in October 2004.
Schroeer noted that Philadelphia made “concrete improvements” with fund balance levels and pensions reforms since S&P revised the outlook to negative in November 2016. However, she said, the city faces “ongoing financial uncertainty” as it tries to achieve the goal of bringing its pension funding level to 80% in 13 years from 43.6% in 2017.
She added that the city also faces cloudy future from its recent pledged support for the Philadelphia School District, which is scheduled to return to local control on July 1 after nearly 17 years and is on pace to amass a $900 million budget deficit by 2023.
“The downgrade is not surprising given the city’s projected declines in fund balances over the next five years and still relative financial uncertainty by having the school district back under local control,” said Janney Capital Markets analyst Erin Ortiz. “It seems that the stable outlook is in part due to S&P’s confidence that the city’s management team will execute on its plans, despite likely revenue raising challenges and funding other priorities.”
Ortiz said Philadelphia has benefited economically from a vibrant higher education and healthcare presence in recent years, but faces potential negative blows from the next recession due to thin reserves compared to other large American cities. Philadelphia ended the 2017 fiscal year with a fund balance on a budget basis of 4.6% of operating expenditures, according to S&P.
Philadelphia Mayor Jim Kenney proposed in his March 1 budget address to provide nearly $1 billion of new revenue to the city’s junk-rated school district to help tackle its projected $900 million deficit estimated by 2023. The Democratic mayor has also focused on ramping up pension payments since taking office in January 2016 budgeting $3.4 billion in pension funding in a five-year plan unveiled last year.
“The City has made substantial progress with a stronger than budgeted fund balance for the current fiscal year, pension reform and favorable economic metrics,” a city spokesperson said in a statement about the downgrade. “However, we continue to face serious structural fiscal issues and we include plans to address those issues in the proposed Five-Year Plan for FY 19-23.”