Nov 14 - Fitch Ratings rates the Chicago Board of Education, IL's (the
board's) approximately $106 million unlimited tax general obligation refunding
bonds (dedicated revenues), series 2012B at 'A'.
The bonds are expected to be sold through negotiation the first week in
December. Proceeds will provide budget relief in fiscal 2013 and fiscal 2014.
Fitch affirms its 'A' rating on the board's approximately $6.1 billion in
outstanding unlimited tax general obligation (ULTGO) bonds at 'A'. The Rating
Outlook is Negative.
The bonds are general obligations, payable from unlimited ad valorem taxes
levied against all taxable property in the City of Chicago. The bonds are
additionally secured by state aid revenue.
KEY RATING DRIVERS
REDUCED FINANCIAL FLEXIBILITY: The labor agreement following the recent Chicago
Teachers' Union (CTU) strike results in increased costs to the Chicago Public
Schools (CPS) of about $103 million annually, or 2% of fiscal 2013 general fund
spending. The increases come at a time of highly stressed operations, when Fitch
believes spending reductions are imperative to maintaining fiscal stability.
BUDGETARY GAP LOOMS LARGE: Prior to the settlement CPS had already planned to
nearly deplete reserves in fiscal 2013. The schools now face a budget gap of
about $1 billion in fiscal 2014. The gap arises largely from the combination of
the new labor contract, use of reserves to balance the current fiscal year's
budget, and a dramatic jump in pension costs in fiscal 2014.
OUTLOOK REMAINS NEGATIVE: Fitch believes dramatic changes are necessary over the
next several months to support operating and fixed cost spending in fiscal 2014.
Options within the board's control appear unlikely to be sufficient. The coming
challenges appear considerably greater than they have been historically.
PENSION WEAKNESS: Weak pension funded ratios were exacerbated by payment
deferrals for the teachers' plan in fiscal years 2011-2013. The city's plan in
which non-teachers participate is even more poorly funded. Proposed pension
reform, if approved by the state, could reduce the pressure notably. However,
approval is uncertain and outside the district's control.
UNFAVORABLE DEBT POSITION: The district's debt levels are above average with
very slow amortization. The current debt restructuring will further slow overall
CAPITAL PLAN REDUCED: Expectations for future capital spending are down
significantly from prior plans. However, Fitch believes maintenance-related
needs may exceed planned spending.
ECONOMY RECOVERING SLOWLY: Chicago ('AA-', Stable Outlook) benefits from a large
and diverse economic core whose employment base and housing market are
nonetheless under substantial stress.
WHAT COULD TRIGGER A RATING ACTION
PERSISTENT FISCAL 2014 GAP: A further rating downgrade might result if CPS is
unable to address the large upcoming budget gap without implementing measures
that reduce future financial flexibility, such as further deferral of fixed cost
payments or use of more than a moderate level of one-time solutions to close the
MOUNTING FIXED COSTS: Fitch believes management's ability to address mounting
fixed costs, including full funding of annual pension contributions and
increased debt service, will be tested. Inability to contain growth in these
costs would additionally pressure the rating.
CPS served 404,151 students in school year 2011/2012 in a district with 675
schools that is coterminous with the city. Enrolment trends are slowly declining
and management reports its demographer projects continued declines of about 1%
STRIKE SETTLEMENT INCREASES COSTS, REDUCES FLEXIBILITY
The settlement of the recent CTU strike results in cost increases of about $103
million annually over the four-year term through fiscal 2016. The fourth year of
the contract will be implemented at CPS's option, with CTU approval. The
contract includes COLAs, step and lane increases, and the addition of 512
positions to accommodate a longer school day. CTU represents about 74% of board
Prior to the tentative agreement Fitch cited the need for CPS to address a large
budgetary imbalance of at least $770 million in fiscal 2014 (14.9% of fiscal
2013 budgeted spending). The district now estimates that imbalance to be about
$1 billion. Fitch believes the settlement narrows the options for achieving
balance as salary and wage increases are already built in. Fitch also believes
long-term savings included in the agreement primarily avoid, rather than reduce,
future costs. These include eliminating a pension enhancement program, reducing
sick day accumulation, and changing the step increase structure. However, the
changes should have a positive impact on pension ARC payments.
RESERVES HISTORICALLY MODERATE BUT VOLATILE
Fiscal 2011 ended with a large operating surplus after transfers of $316 million
and a sound unrestricted general fund balance (the sum of committed, assigned,
and unassigned under GASB 54) of $521 million or 10.6% of spending. Both the
surplus and the balance were much improved from fiscal 2010, which ended with a
general fund operating deficit of $102 million and an unreserved balance of 4.1%
While the build-up of reserves provided a sound cushion for the financial
pressures to come, it was garnered primarily through non-recurring sources.
These included the release of city tax increment funds ($127 million), a debt
restructuring ($110 million), pension relief ($400 million per year through
fiscal 2013), and federal stimulus funds through the EduJobs program ($50
million per year through fiscal 2012).
The fiscal 2012 CAFR is not yet available, but Fitch anticipates it will show a
modest drawdown in general fund balance and a still-solid ending unrestricted
general fund balance of about 8% of spending. Results reflect continued pension
relief, EduJobs funding, and the suspension of a contractual 4% salary increase
based on projected financial strain. Favorably, state aid payment delays had
lessened by the end of fiscal 2012 to one month from three. At present the
delays are back up to five months but budgeted to recede to three months by
FISCAL 2013 BUDGET DEPLETES RESERVES, SETS UP GAP FOR 2014
The amended fiscal 2013 budget, reflecting the labor settlement, includes use of
all but $63 million in unrestricted reserves to support spending. The additional
spending related to the CTU contract will be accommodated mainly with
non-recurring actions, including the upcoming debt restructuring that defers
debt service spending of $50 million in each of fiscal years 2013 and 2014.
Fitch views the fiscal 2013 budget situation with particular concern given a
required $338 million increase in pension spending in fiscal 2014 to $534
million (10.3% of budgeted fiscal 2013 spending).
Fitch believes significant actions will be necessary in fiscal 2014 to avoid a
deficit position. Fitch's concern that near-term non-recurring solutions will
come at the expense of longer-term flexibility is heightened given the increased
size of the gap and reduced ability to achieve productivity gains from labor.
Recent examples of such solutions include the deferred pension payments and debt
restructuring that deferred principal payments.
Recent financial management turnover is an additional challenge for the
district. Both the CEO and CFO were just replaced, and senior management
vacancies include the controller and treasurer positions.
PENSION LIABILITIES CONSISTENT WITH WEAK REGIONAL NORMS
Pension funded ratios have dropped significantly in the last several years due
to a combination of lower-than-expected investment returns and payment deferrals
for the CTU plan granted by the state for fiscal years 2011-2013. As of June 30,
2011 the plan was 59.9% funded, or 51.4% using a 7% return rate, compared to
79.7% and 68.4%, respectively, in fiscal 2008. District non-teachers participate
in even more poorly funded city plans.
The increased pension payment beginning in fiscal 2014 is needed to bring
payments up to the level required to increase the CTU plan's funded ratio to 90%
by fiscal 2059. Fitch does not believe this is an aggressive goal with respect
to addressing the unfunded liability and expects the district will be challenged
to meet it.
Pension reform being discussed at the state level could have a meaningful impact
on the board's liability but so far there are no solid indications of when, if,
or how it would be implemented. Other post-employment benefits (OPEB) are
similarly underfunded but annual payments are capped at $65 million, leaving an
increasing burden for employees and retirees. Fitch is concerned about not only
these plans but other city, Cook County, and State of Illinois plans which are
all poorly funded.
DEBT CONSTRAINTS MAY HINDER ABILITY TO ADDRESS CAPITAL NEEDS
The district's overall debt levels are above average at 6.7% of market value,
with very slow amortization of 31% in 10 years, the result of long-dated debt
and restructurings. The upcoming restructuring will further decrease
amortization slightly. However, Fitch views positively a reduction in variable
rate debt to 23% from 49% in the last five years. Management has worked to
stagger liquidity facility expiration dates to reduce rollover risk, and reports
favorable bids for recent liquidity agreements.
Planned capital spending has been reduced to $100-200 million annually through
fiscal 2017, compared to $500-700 million spent in each fiscal year between
fiscal 2009 and fiscal 2012. Fitch views positively management's attempts to
reduce its debt burden but is concerned that slated amounts will be insufficient
to keep up with essential capital maintenance needs on the district's vast and
ECONOMY SHOWING SOME IMPROVEMENT:
Chicago serves as the economic and cultural hub for the Midwest region and
maintains good prospects for long-term stability if not growth. The city gained
over 30,000 jobs in 2011 primarily in professional and business services despite
reductions in both manufacturing and public service. Chicago's population
totaled 2.7 million in 2011, down 7% from the 2000 census, but still accounts
for 21% of the state's entire population.
Socioeconomic indicators are mixed with elevated unemployment and individual
poverty rates, slightly below average per capita income levels, but strong
educational attainment levels. As of July 2012, the city's unemployment rate at
10.5% was still well above the state and national averages. A 2.7% boost to
employment drove a notable improvement in the rate from the 12.3% recorded in