After several years of rating upgrades, the Chicago Public Schools face a tougher road back to investment grade due to the fiscal turmoil caused by the COVID-19 pandemic that dampens state aid prospects and future property tax values, Moody’s Investors Service warns in a report.
For years the district struggled with billion-dollar deficits, turning to one-time measures, such as using reserves and pushing off debt service payments to cope. That left the ratings deep in junk territory.
Over the past two years, the state’s largest district won a series of upgrades as it benefitted from a state overhaul of its education funding formula that called for steady annual increases and it won local and state support for additional pension funding from the property levy and the state budget. The district struck an expensive five-year contract last year with teachers after a strike, but the certainty it provided was beneficial.
The progress is now threatened as the pandemic’s economic impact may be felt on two major source of district revenue streams — state aid and its property tax levy for pensions.
Moody’s, which rates the Chicago Board of Education four rungs below investment grade at B1 with a stable outlook, looked at the possible course of the district’s expenses and revenues. Analysts concluded that under various scenarios the district’s liquidity position could improve by as much as $200 million or dwindle by as a much as $650 million.
“Given the relatively limited band of potential outcomes, a substantial change in CPS’ credit quality would take multiple fiscal years,” said Moody’s lead analyst on the credit Coley Anderson. “Significant improvement in the district’s financial position is less likely now as a result of the weakened state budget environment caused by the coronavirus and we now view downside risk as greater than the upside risk.”
Under one scenario, the district could see continued strong growth of state funding that offsets a potentially modest levy decline. “CPS maintains, if not improves, its credit quality. CPS had been on this path until recently, but the probability of this scenario coming to fruition has dimmed with softening state revenue,” Moody’s warned.
Under a second scenario, state aid growth moderates and the pension levy materially declines. “As a result of coronavirus-related state revenue losses, this scenario is increasingly likely and serves as our base case,” Moody’s said.
Under a third scenario, state aid is frozen and the pension levy drops substantially. That assumes state funding is flat for two years before increasing modestly and there is a significant decline in pension levy revenues in fiscal 2022.
This would likely lead to material operating deficits and increased cash-flow borrowing. “While this could lead to a deterioration of district credit quality, CPS is unlikely to return to previous financial lows,” Moody’s said.
Moody’s assumed expenses that reflected anticipated growth in costs laid out in the teachers’ contract, existing debt levels, and the ability to trim expenses by 1% if needed.
Given recent economic challenges resulting from the pandemic, a decline in assessed valuation appears likely, which will eventually impact the district’s pension levy revenue. The levy generated $500 million in fiscal 2020, Moody’s said. The county assessor has said he plans to make adjustments due to the pandemic.
The pension levy size rises and falls based on property tax valuations.
The district has authority to increase the tax rate on its other property tax levies to capture growth that doesn’t exceed state tax caps.
The district already stands to lose ground on state aid under the fiscal 2021 state budget adopted by the legislature. It doesn’t cut aid, but it doesn’t fund the expected $350 million annual increase that districts were expecting under the 2017 funding overhaul. In fiscal 2020, the district saw an increase of $64 million.
Whether the state restores the funding looms large. If the state receives new federal aid to cover tax hits or if voters approve a constitutional amendment on the November ballot that allows the state to move to a graduated income tax rate structure from the current one, the state might raise funding.
Cuts may loom in the absence of federal funding, and in future years if the income tax change doesn’t occur, but they would have to be deep to impact CPS given its status under state rankings based on funding adequacy levels.
The district, which moved to online-learning when Gov. J.B. Pritzker shuttered schools in March, is currently managing COVID-19 expenses with $206 million in Federal Coronavirus Aid, Relief and Economic Security Act funding.
Moody’s in May moved the district’s outlook to stable from positive as it then believed “state and local revenue is unlikely to continue to grow as previously expected, which will make meaningful improvement in the district’s financial profile more difficult to achieve over the next 12-18 months.”
S&P Global Ratings in April revised the Chicago Board of Education’s outlook on its junk level rating of BB to stable from positive. It was one of the tax-secured ratings impacted by the rating agency’s sector-wide shift to stable from positive. The district has $8 billion of debt.