CHICAGO — The Chicago school district is on the last rung above junk bond status after a two-notch downgrade from Moody's Investors Service.
Moody's late Friday lowered its rating on the Chicago Board of Education to Baa3 from Baa1, leaving its negative outlook.
Moody's, which already cited concerns about the district's governance links to Chicago, was expected to downgrade the schools following its Feb. 27 downgrade of Chicago to Baa2.
But Moody's took the district down two notches, compared to the one-notch drop it gave Chicago and the Chicago Park District last week.
The school district's $6.3 billion of debt retains A-level ratings from other rating agencies.
The strain of the city's $20 billion in unfunded pension obligations is the main driver of the downgrades Moody's has given the city and the agencies that share its tax base.
CPS is struggling with its own daunting pension and budget woes.
Unlike the city which enjoys home rule status, the school system has limited revenue raising flexibility due to property tax caps and limited extra aid is expected from the state as it grapples with an estimated $6 billion deficit in its next budget.
CPS has watched its credit ratings deteriorate in recent years as its pension contributions rose following a three-year partial holiday approved by state lawmakers and it turned to other one-time maneuvers like debt restructuring and reserve use to erase red ink. The schools are now facing a $1 billion deficit in the next budget beginning July 1.
"The Baa3 rating reflects CPS's continued reliance on reserve use to accommodate a portion of ongoing operating expenditures, particularly pension contributions, which will steadily increase in the coming years," Moody's wrote.
The rating also reflects the district's close governance ties to Chicago and a shared, and highly leveraged, tax base.
Mayor Rahm Emanuel holds sway over board appointments and handpicks the district's chief executive officer.
After a financial crisis in 1979, the district's finances were placed by the state under the control of a special board until 1995 when control was handed over to then Mayor Richard M. Daley.
The property tax caps limit annual levy increases to the lesser of 5% or the change in the consumer price index. The controversial closure of 50 school several years ago leaves CPS few additional major cost cutting options.
CPS's main credit strength is a "very large tax base and diverse regional economy," Moody's said.
The district must fund a pension contribution of $688 million in its next budget. That's up from $634 million this year, $601 million in fiscal 2014, and $197 million in fiscal 2013, the final year of its partial holiday.
The district has since returned to a state-mandated funding structure aimed at bringing the teachers' fund to a 90% funded level by 2059. The funding schedule, which remains below an actuarially based contribution, calls for payments to rise to $12.3 billion in 2039.
"Even with this relatively lenient funding framework, the increasing contributions will place material strain on the district's operating budget," Moody's warned.
The school district is carrying $9.5 billion of unfunded liabilities. Under Moody's adjusted net pension liability calculation the figure rises to $17.6 billion.
The district is clamoring for relief and reforms at the state level, but it's unclear what if any the General Assembly will take this year. Local reforms have largely been put on hold until the Illinois Supreme Court finishes its review of reforms to the state's pension funds. Oral arguments on a union-sponsored legal challenge are slated for Wednesday.
"CPS officials are actively working to identify revenue enhancements and expenditure adjustments that will be needed to accommodate the increased payments, but solutions remain uncertain," Moody's wrote.
CPS said if the 2013 state reforms are uphold by the state's high court it stands to see $210 million in relief but more state approved help is needed. The downgrade "is based primarily on the District's pension crisis and should come as a shock to no one," spokesman Bill McCaffrey said in a statement. "CPS is facing downgrades because of broken politics that force Chicago taxpayers to pay twice for teacher pensions - once for CPS educators, and a second time for suburban and downstate teachers...CPS will be forced to decide between funding the pensions of retirees and funding the education of its students."
A failure to structurally balance its budget, further reductions in operating reserves and liquidity, and further deterioration in the city's rating could drive a subsequent downgrade.
Despite past draws, the district's operating reserve remains satisfactory and is expected to close out fiscal 2015 at $300 million. The district operates on a nearly $6 billion budget. Moody's expects further reserve fund draws as the district deals with rising pension payments. The district was able to replenish some reserves this year after undertaking a controversial accounting change that counted tax collections received over the summer in the prior fiscal year.
About 18% of the district's debt portfolio is structured in a floating-rate mode with nine direct loans or bank support. Further pressures on the credit include refinancing risks on a letter of credit that expires March 27 with Wells Fargo Bank NA on $89 million from a floating-rate 2000 issue.
The district also faces a March 29 expiration on its 2011 direct loan agreement on $89 million with PNC Bank NA. The interest rate risk on a portion of the issue is hedged by a fixed payer swap agreement with Royal Bank of Canada under which the district pays 3.823% and receives 70% of the London Interbank Offered Rate.
The district told Moody's it would deal with any unexpected costs associated with the two issues with $194 million of available reserves in a debt service fund. The board recently approved a borrowing plan to remarket the 2000 bonds with a new LOC, convert $300 million from a line of credit to long-term debt, and refund $220 million for savings.
The downgrade moves the district closer to swap termination triggers, but it retains breathing room as all the contracts require a downgrade by two rating agencies to below the Baa2 or BBB level. CPS has 10 fixed payer interest rate and basis swap agreements in its debt portfolio. The total mark-to-market valuation of the ten swaps as of March 2 was negative $262.9 million, Moody's said.
Standard & Poor's rates the Board of Education A-plus, with a stable outlook. Fitch Ratings rates the board A-minus with a negative outlook. Debt service on CPS's general obligation paper is paid from the district's general state aid although it's secured by the district's unlimited property tax levy.
CPS operates 667 schools with enrollment of about 400,500 students.
