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Fitch Rates Chicago Board of Education, IL's $763MM ULTGOs 'BB-' and $86MM CIT Revs 'A'.

New York: Fitch Ratings has assigned a 'BB-' rating to the following Chicago Board of Education, IL (CBOE) bonds:

--$450 million unlimited tax general obligation refunding bonds (dedicated revenues), series 2018C;

--$313 million unlimited tax general obligation bonds (dedicated revenues), series 2018D.

Fitch also affirms the following 'BB-' ratings:

--approximately $7 billion outstanding unlimited tax general obligation (ULTGO) bonds;

--Issuer Default Rating (IDR).

The Rating Outlook is Positive.

Fitch has also assigned a 'A' rating to the $86 million dedicated capital improvement tax (CIT) bonds, series 2018 and affirmed the 'A' rating on $64 million outstanding CIT bonds.

The Rating Outlook is Stable.

Proceeds of the ULTGO bonds will be used to refund outstanding debt and provide funding for various capital improvements as listed in the capital improvement program. Proceeds of the CIT bonds will fund various capital improvements as well as a deposit to the debt service reserve, capitalized interest and costs of issuance. The bonds are expected to sell via negotiation the week of Nov. 28.


The ULTGO bonds are unlimited tax general obligations of the CBOE payable from dedicated CBOE revenues in the first instance and also payable from unlimited ad valorem taxes levied against all taxable property in the city of Chicago. The CIT bonds are secured by a first priority lien on CIT revenues.


The 'BB-' IDR and ULTGO rating reflect the history of structurally imbalanced financial operations driven by a strained revenue environment and growing pension pressures that resulted in an accumulated general fund deficit. The Positive Outlook reflects CBOE's progress toward structural balance as evidenced by the inclusion of improved school funding in the state's fiscal 2018 and 2019 budgets, the projected restoration of positive reserves for fiscal 2018 and an improved liquidity position leading to lower levels of cash flow borrowing.

The district is receiving significantly more ongoing state aid, both for operations and for pension expenses, under the new state funding framework enacted in 2018 than it was under the previous framework. Importantly, the bulk of state funding to the district is now determined as part of overall funding decisions for schools statewide, rather than being considered separately. The higher funding level associated with the new funding framework is ongoing under current law, and the risk of funding declines will be largely tied to statewide funding levels, mitigating the risk of funding cuts targeted to CBOE. The recent election of a new governor may also signal lower risk that cuts will be targeted at school districts. Financial pressures will remain, but the additional funding and revised funding framework should improve the amount, timing and potential volatility of state aid to Chicago Public Schools (CPS) and allow for reversal of the previous downward trajectory.

The 'A' rating on the dedicated tax bonds reflects the strong resilience of the pledged tax security without regard to the issuer's general creditworthiness. The rating is distinct from the 'BB-' IDR, due to Fitch's assessment that the pledged revenues meet the definition of 'special revenues' under the U.S. Bankruptcy Code and therefore, bondholders are legally insulated from any operating risk of the board.

Economic Resource Base

Chicago acts as the economic engine for the Midwestern region of the U.S. The city's residents are afforded abundant employment opportunities within this deep and diverse regional economy. The city also benefits from an extensive infrastructure network, including a vast rail system, which supports continued growth. The employment base is represented by all major sectors with concentrations in the wholesale trade, professional and business services and financial sectors. Socioeconomic indicators are mixed as is typical for an urbanized area, with above-average educational attainment levels, above average per capita income and elevated individual poverty rates. Population trends are flat, and enrollment is declining.



Revenue Framework: 'bbb'

Fitch expects natural revenue growth, absent new revenue action, to keep pace with inflation, given expectations for property tax growth and relatively flat state aid growth following the increases associated with the new funding formula. CPS has no independent legal ability to raise revenues.

Expenditure Framework: 'bbb'

Fitch expects the natural pace of expenditure growth to exceed that of revenues, necessitating ongoing budget management. CPS has made significant cuts in recent years, and Fitch believes that the practical ability to cut spending throughout the economic cycle is limited. Recent improved funding has allowed some restoration of service levels, which may lead to increased expenditure flexibility over time.

Long-Term Liability Burden: 'a'

The long-term liability burden is elevated, but still in the moderate range, relative to the resource base.

Operating Performance: 'bb'

The district's accumulated general fund deficit resulted from years of structurally imbalanced operations. Fitch expects budgetary balance to improve over time, given expected gains under the new state funding formula. The new formula should also improve cash flow timing and liquidity from very weak levels.


Special Revenue Analysis: The 'A' rating on the dedicated CIT bonds is based on a dedicated tax analysis without regard to the board's financial operations. Fitch has been provided with legal opinions by board counsel that provide a reasonable basis for concluding that the tax revenues levied to repay the bonds would be considered 'pledged special revenues' under Section 902(2)(e) of the U.S. Bankruptcy Code in the event of a board bankruptcy.

Predictable Revenues: Growth in the levy (currently $56.2 million) is set by state statute at the rate of inflation; however, the levy jumps up in 2033 by $142.5 million, then resumes inflation-based growth. Debt service schedules are sized to the minimum levy, without assuming inflationary increases.

Strong Resilience of Pledged Tax Security: A multi-year levy with pre-determined minimum amounts combined with limited volatility in historical property tax collection rates support strong financial resilience for debt service coverage throughout economic declines.


Structural Balance: Demonstrated progress toward structural balance and achievement of targeted fiscal 2019 reserve levels could result in an upgrade of the IDR and GO bond ratings. Conversely, failure to achieve targeted reserve levels could result in a return of the Outlook to Stable.

Liquidity Pressure: Liquidity remains narrow, albeit improved under the new school funding structure, and the district remains dependent upon external sources of liquidity. The IDR and GO bond ratings assume continued market access for necessary cash flow borrowing.

Property Tax Collection Rates: The CIT dedicated tax bond rating is sensitive to declines in property tax collection rates of a scale that would materially erode the protection inherent in the expected coverage ratios, given the fixed-dollar levy, 1.1x additional bonds test and moderate historical delinquency experience.


The Chicago Board of Education provides preK-12 education to over 370,000 students within the city of Chicago. Its taxing jurisdiction is coterminous with the city of Chicago. CPS manages the school system, which is composed of 661 school facilities.

CPS relies on state funding for a significant amount of support. In 2018, the state legislature passed a new 'evidenced-based funding model' for schools. CPS is now receiving a materially increased amount of state support relative to prior years and should benefit from a hold-harmless provision that protects the district from demographic-related cuts in state aid. The hold-harmless provision should be particularly beneficial given the trend of declining enrollment.

Illinois (IDR of BBB/Negative) is a large, wealthy state with a diverse economy centered on the Chicago metropolitan area. The state's 'BBB' IDR and GO bond rating reflect an ongoing pattern of weak operating performance and irresolute fiscal decision making that has produced a credit position well below the level that the state's solid economic base and still substantial independent legal ability to control its budget would support. The closer alignment of current revenues and current spending in the fiscal 2018 budget with passage of a permanent tax increase was a positive step. Negatively, structural balancing actions on the expenditure side were limited and the fiscal 2019 budget maintained a reliance on one-time measures.

The Negative Outlook on the state's rating reflects Fitch's assessment that Illinois' fiscal pressures may accelerate in the near term as the fiscal 2019 budget entails significant implementation risk and uncertainties remain regarding ongoing fiscal management and decision making, particularly given the contentious political environment in the state. In Fitch's opinion, the state will be challenged to rebuild its financial resilience given the persistence of a sizable accounts payable backlog; the state's practice of delaying payments in response to budget imbalance has negatively affected liquidity for recipients of state funds, including CPS. Fitch expects natural growth in state revenues to be slow.

Revenue Framework

Property taxes provided 51% and state aid 25% of general fund revenues in fiscal 2017, but the new state funding formula increased the share of support derived from state aid beginning in fiscal 2018.

Growth prospects for revenues are slow, absent policy action. Revenues were budgeted to rise significantly in fiscal 2017, as the result of both local and state policy action, but actual results fell short, particularly with respect to state aid. The effect of the new funding formula should become apparent in fiscal 2018 operating results, which are expected to show a surplus sufficient to return the unrestricted general fund balance to positive territory. Following that large jump in base funding levels, Fitch anticipates subsequent years' revenue growth will be about the level of inflation, taking into account property tax revenue trends and expectations of relatively flat state aid over time.

Newer sources of revenue dedicated to pension expenses include a $250 million property tax levy effective fiscal 2017 and $154 million in new property taxes effective fiscal 2018, neither of which is constrained by the Property Tax Extension Limitation Law (PTELL).

Independent legal ability to raise revenues is limited, as it is for many school districts in the U.S. Annual growth in the property tax levy for operations is limited by PTELL to the lesser of 5% or the rate of inflation.

Expenditure Framework

The district devoted 54% of fiscal 2017 general fund spending to instruction, 27% to support services and 13% to pensions.

Fitch expects the natural pace of spending growth to be above natural revenue growth, given rising pension contributions and assumed wage increases. Management has actively managed expenditure growth, with a series of substantial cuts over the past several years including administrative cutbacks, school closures and layoffs. The new dedicated revenue stream for pensions, combined with the state's taking responsibility for the normal cost for pensions ($221 million in fiscal 2018) should reduce the degree to which required pension payments compete for operating dollars over time.

CPS's practical ability to make future expenditure cuts is limited, in Fitch's opinion, with cuts likely to meaningfully but not critically reduce core services at times of economic downturn. Such cuts could include those for programs and labor costs. As it receives increased state funding, the district has begun adding back some previously cut services, which could provide an incremental margin of spending flexibility over time. A moratorium on school closings expired at the end of fiscal 2018, which may also present an opportunity for efficiencies.

Fixed carrying costs for debt service and actuarially-determined pension contributions are currently sizable at 22% of governmental spending in fiscal 2017; however, Fitch's supplemental pension metric, which estimates the annual pension cost based on a level dollar payment for 20 years with a 5% interest rate, indicates that carrying costs are vulnerable to significant future increases. For more information, see "Revised Pension Risk Measurements (Enhancing Pension Analysis in U.S. Public Finance Tax-Supported Rating Criteria)" dated May 31, 2017.

Long-Term Liability Burden

The long-term liability burden is elevated but still moderate relative to the resource base. The adjusted net pension liability plus overall debt represents about 26% of personal income. Overlapping debt accounts for 35% of the long-term liability burden, with net pension liability representing 42% and direct debt approximately 23%. Amortization of direct debt is slow with about 25% of debt scheduled for retirement in 10 years. Identified future borrowing needs over the near to medium term are moderate but may exceed the amount amortized. Nevertheless, Fitch anticipates that the long-term liability burden will remain solidly within the 'a' category.

Pension benefits for teachers are provided through the Public School Teachers' Pension and Retirement Fund of Chicago (CTPF), a cost-sharing multi-employer defined benefit plan in which CPS is the major contributor. Under GASB 68 reporting, the plan reported a 48% asset to liability ratio as of June 30, 2017. Fitch estimates the ratio to be lower at about 39% when adjusted to reflect a 6% return assumption. The weak ratios stem from several years of pension payment holidays and poor investment returns. The district dramatically increased pension funding in fiscal 2014 to comply with a state law requiring payments sufficient to reach a 90% funding level by 2059. Fitch expects pensions to continue to be a pressure, particularly given the longer than typical amortization period.

Pension benefits for other personnel are provided through the Municipal Employees' Annuity and Benefit Fund of Chicago (MEABF), a cost-sharing multi-employer defined benefit plan whose major contributor is the city of Chicago. CPS does not directly contribute to the plan and has no liability for it.

The other post-employment benefits (OPEB) liability is limited.

Operating Performance

Financial resilience is weak as CPS lacks a reserve cushion and would be challenged by even a moderate economic downturn. However, prospects for restoration of operating balance and reserves have improved with the new state funding framework and CPS is projecting a $526 million net general fund operating surplus and the restoration of unrestricted reserves for fiscal 2018. As noted above, the school funding legislation passed by the state legislature last year included an evidence-based funding model for schools state-wide that improves the amount, timing and potential volatility of state aid to CPS.

The new law is benefitting CPS in several ways. It provided $314 million in additional state funding in fiscal 2018, including $221 million for state assumption of the normal cost for pensions, $70 million in new formula funding, and $23 million in early childhood and other funding. It also included authorization for an additional $130 million property tax levy for pensions, which, unlike the operating levy, will not be subject to PTELL restrictions.

The new fiscal 2018 revenues were in addition to the additional funding procured in fiscal 2017, including a $250 million pension levy, which also is not subject to PTELL restrictions and $204 million in additional state aid, which was included in the base funding level for the evidence-based funding model going forward. The new formula also delivers more of CPS's aid in the form of general state aid rather than categorical block grants. This is favorable to CPS as block grants are scheduled for disbursement less frequently than general state aid and were greatly delayed during the state budget impasse, contributing to CPS's financial distress. The new funding formula also includes a hold harmless clause, which should protect CPS from state aid declines based on demographic factors (enrollment declines, improved poverty rate, etc.) and therefore reduce potential revenue volatility in the future.

Much of the historical structural imbalance stems from the lack of actuarial funding of pensions, including state-authorized reduced pension payments during the great recession. The subsequent resumption of full payments and shift in fiscal 2014 from statutory to actuarially-based pension payments presented a dramatic rise in spending without a corresponding revenue increase until recently. Budgets prior to fiscal 2018 also relied upon unsustainable practices including appropriated reserves, scoop and toss restructurings for budgetary relief, optimistic budgeting of revenues and lengthening the accrual period for property tax collections.

A series of large consecutive operating deficits through fiscal 2017 underscored CPS's structural budgetary imbalance and eroded its financial reserves. Reserves were completely exhausted in fiscal 2016. In fiscal 2017, the accumulated general fund deficit deepened to $275 million (5% of spending) or $355 million (7%) on an unrestricted basis. The amended fiscal 2018 budget reflected the effects of the new state funding framework, which may allow payment of delayed block grants, $16.6 million of which are still outstanding. It targeted a positive ending general fund balance of $29 million, or less than 1% of spending. Projected results indicate general fund balance will rise to a positive $275 million. If achieved, such a cushion would represent a material improvement over past performance but would still provide only limited gap-closing capacity in a downturn or other unexpected operating, funding or liquidity stress.

The fiscal 2019 budget represents a 5% increase over fiscal 2018 and includes increases for new educational spending, wages, healthcare costs and higher pension contributions, some of which is related to lowering the discount rate from 7.25% to 7.00%. The budget also assumes a reduced amount of federal and Medicaid revenue as well as the lowest amount of TIF revenue in the past four years. The district anticipates it will likely meet its fund balance target of $237 million (5% of spending) at fiscal 2019 year-end.

Liquidity has been extremely weak, with nine days of cash on hand at the end of fiscal 2017. CPS's general fund cash position declined dramatically from $1.1 billion at the close of fiscal 2013 to $57 million at the end of fiscal 2016 and rebounded slightly to $161 million in fiscal 2017. Fiscal 2018 cash flows show improved liquidity provided by new revenue sources and the improved amount and timing of state aid, with the maximum draw on the cash flow line of credit falling to $1.094 billion in fiscal 2018 from $1.55 billion in fiscal 2017. The maximum expected draw for fiscal 2019 is projected to be a further improved but still high $994 million. Notably, CPS has demonstrated consistent access to external sources of liquidity, even during periods of fiscal stress. Most recently, it successfully sold tax anticipation notes via competitive sale.


The bonds are secured by a first priority lien on CIT revenues. The specific features of the CIT bonds meet Fitch's criteria for rating special revenue obligation debt without consideration of the board's general credit quality. Fitch believes bondholders are effectively insulated from the operating risk of the board as expressed in its IDR.

Fitch sets a high bar for considering local government tax-supported debt to be secured by special revenues, which provide security that survives the filing of a municipal bankruptcy (in preservation of the lien) and benefit from relief from the automatic stay provision of the bankruptcy code. Fitch gives credit to special revenue status only if, in the agency's view, the overall legal framework renders remote a successful challenge to the status of the debt as secured by special revenues under Section 902 (2) (e) of the U.S. Bankruptcy Code.

Fitch has identified a number of elements considered sufficient to reduce the incentive to challenge the special revenue status given the definitions outlined in the bankruptcy code. These include clear restrictions on the use of pledged revenues for identified projects and clear separation from the entity's operations. Fitch has undertaken an extensive review of the statutory provisions that govern the use of the CIT. Those provisions, along with the legal documents governing the bond issuance, provide sufficient strength for Fitch to rate the CIT bonds higher than the IDR.

The board is authorized under the Illinois School Code to levy the CIT on all taxable property within the district, which is coterminous with the city of Chicago. State statute limits the permitted uses of CIT revenues to include construction, acquisition and equipping of school and administrative buildings, and site improvements. The board has identified specific capital projects in the bond resolution that may be funded either by bond proceeds or by residual CIT revenues. Any amendments to the project list must be passed by board resolution. The revenues legally cannot be used for general operations of the board.

Under the flow of funds, the CIT revenues are collected by the county collectors of Cook and DuPage Counties. The board has directed the collectors to transmit the CIT revenues directly to an escrow agent. The escrow agent transfers revenues needed for payment of debt service to the bond trustee daily. Revenues in excess of those required to meet annual debt service may be available to reimburse CPS for authorized capital expenditures.

The board covenants not to revoke the direction to the county collectors as long as the bonds are outstanding. Based upon review of bond counsel opinions Fitch believes that any future attempt to revoke the direction to the county collectors would be contrary to state statute.


The multi-year levy is set by resolution at the time of bond issuance and no policy action is required to offset potential declines in assessed value. Importantly, the minimum amount of the levy is knowable in advance and the debt service schedule is sized to that, allowing for a minimum of 1.1x coverage. This leaves only the risk of diminishing collection rates, which historically have been well within the norm for U.S. municipalities.

To evaluate the sensitivity of the dedicated revenue stream to cyclical decline, Fitch considers both revenue sensitivity results (using a 1% decline in national GDP scenario) and the largest decline in revenues over the period covered by the revenue sensitivity analysis. Since the CIT revenue history is insufficient to conduct this analysis, Fitch uses a proxy of overall property tax collection rates, which it believes approximates future risk to CIT revenue sufficiency.

Based on historical property tax collection rates, Fitch's Analytical Sensitivity Tool (FAST) generates a fairly modest 1.7% scenario decline in pledged revenues. The largest cumulative decline was a 2.7% decline during the recession between 2008 and 2009.

Given the 1.1x coverage, pledged revenues could withstand a 9% decline before they were insufficient to fully cover debt service. This is 3.3x the largest actual cumulative decline, or 5.3x the recessionary impact estimated in Fitch's FAST scenario. Recent tax increases by Chicago-area governments could contribute to delinquencies beyond historical experience in a recession.


The additional bonds test dictates that projected CIT revenues must provide at least 1.1x coverage of annual debt service in each bond year. Projections may not include assumptions for inflationary increases prospectively. Fitch's analysis assumes the pledged revenues would be leveraged to the full extent allowable under the additional bonds test.
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Publication:Daily the Pak Banker (Lahore, Pakistan)
Geographic Code:1U3IL
Date:Jan 21, 2019
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