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Improved reserve levels helped provide the School District of Philadelphia with its first bond rating upgrade in seven years.

Moody’s upgraded the nation’s ninth largest public school system one notch to Ba2 from Ba3 late Friday citing “considerable improvement in the district's still strained financial position.” The district remains junk, but Moody's also changed the outlook on its roughly $3 billion of outstanding debt to positive from stable.

Moody’s analyst Nicole Serrano noted that the district posted three straight years of healthy surpluses from 2015 to 2017. The city’s $2 per-pack cigarette tax enacted in 2015 and the extension of a 1% sales tax where the first $120 million of revenue were dedicated to Philadelphia schools generated nearly $180 million in 2016, or 7% of revenues, according to Serrano.

“We are making progress in schools and classrooms across the city and we continue to make progress to ensure the strongest financial footing for the School District of Philadelphia,” Superintendent William R. Hite said in a statement. “This upgrade continues our momentum as a district and ends the first week of school on a tremendous high note.”

Serrano cautioned that despite improved finances, the district is projecting operating deficits starting in 2018 and a negative fund balance by 2019 due largely to an 8% growth in charter school costs over the next five years. She notes that the district is also limited as the only district in Pennsylvania that cannot independently levy taxes, relying on city and state governments for crucial revenue sources. The district’s expected operating surplus for the 2017 fiscal year is $79 million, 2.8% of revenue.

“This is a considerable limitation for the district, particularly given continued rising costs,” said Serrano. “This lack of flexibility in revenue raising ability makes maintaining structural balance a significant challenge.”

Philadelphia schools have an enhanced A2 bond rating on direct general obligation debt thanks to the Pennsylvania School District Fiscal Agent Agreement Intercept Program. Moody’s maintained the rating under the program, which allows the state treasurer to withhold state aid and make payments directly to the bond trustee.

Moody’s credited the district’s management with devising strategies to navigate financial challenges and charter school pressures with the complexities of running a large urban public school system. The district was also lauded for its financial commitment to the classroom including a new five-year $440 million program that includes goals to enhance literacy, college and career readiness.

“We view this type of district spending as a strong credit positive - improvement in district classrooms should enable schools to be more competitive with charters,” said Serrano. “This type of investment, along with the negotiation of a long-awaited teachers' contract, also improves the overall perception of the district as a viable provider of education services to city residents and tax-payers.”

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School bonds Ratings School District of Philadelphia Pennsylvania