Fitch Ratings downgrades CPS bonds

Fitch Ratings, one of three rating services that rate almost all corporate and government debt in the world, announced on Thursday, October 7, 2010, that it was downgrading the debt of the Chicago Board of Education to "A+" from the higher "AA-" rating. The new rating is still "investment grade" but indicates that CPS finances are causing worries on Wall Street. Substance is checking with the other two ratings agencies (Standard and Poors and Moody's Investors Services).

By the summer of 2010, Ron Huberman, Chief Executive Officer of CPS, had discovered that CPS needed not only a "Chief Financial Officer" and a "Chief Budget Officer" (Christina Herzog, above right), but also a "Deputy Chief Financial Officer." Huberman's choice was a woman he had met from Fitch Ratings, Melanie Shaker (above left), and so CPS hired her some time between March 2010 (when she last rated CPS bonds for Fitch) and August 19, 2010 (at which time she was substituting for CFO Diana Ferguson at the final budget hearing at Corliss High School, where the above photo was taken. Despite a Board policy that the Chicago Board of Education is supposed to approve all top executive and administrative hirings — and the rumor that Shaker is being paid more than $150,000 per year in her newly created position — CEO Ron Huberman continued his habit of making expensive exeucutive hires without going through the Board, and Shaker was on the CPS payroll (and gone from Fitch) by the time the above photo was taken at the Corliss High School budget hearings. Substance photo by George N. Schmidt.Among the reasons cited by Fitch in its revision were the CPS debt burden, pension costs which resume at a higher level in 2014, problems with Chicago and Illinois financing, and, for the first time, the exposure of CPS to risk because of its management of "variable rate debt." Among other things cited are the Board of Education's debt level: "Debt levels are above average and expected to increase given the district's slow amortization and large capital plan."

For the first time since Substance began observing the ratings reports, a rating agency has taken note of the way in which CPS has been managing its debt, especially since CPS began taking on variable rate debt within a complex structure of derivatives that are explained in a complex manner in the Board's "Comprehensive Annual Financial Report" (CAFR). For two years, Substance and CORE members have studied and questioned the CPS derivatives exposure, but CPS officials, including Ron Huberman, have refused to answer specific questions about the risk CPS assumed when it began doing derivatives during the administration of Arne Duncan. "Maintenance of a manageable debt burden in light of the district's variable rate exposure, expiring liquidity facilities, and its sizeable capital plan," is the phrase Fitch uses to explain this problem.

Although the seven members of the Chicago Board of Education voted unanimously last Spring to establish a Finance Committee that is supposed to meet publicly, separate from regular Board meetings, to review and explain CPS financial operations, the Board members have yet to hold such a meeting. In August and September 2010, the Board voted to increase the school system's bond debt on the latest borrowing (to $800 million from $700 million) and continue spending hundreds of millions of dollars on the "new" Jones High School, which has been spending capital projects money for more than ten years since Jones was converted from a commercial high school to the current "College Prep High School" at the end of the 1998-1999 school year. CPS has also continued to add to its capital budget without hold hearings on a current capital improvement plan. The complete Fitch Report follows here:

Fitch Rates Chicago Board of Ed (IL) ULTGOs Series C,D,E,F & G 'A+'; Downgrades Outstanding GOs

Fitch Ratings assigns an 'A+' rating to the following Chicago Board of Education, Illinois' unlimited tax general obligation (UTGO) (dedicated revenues) bonds:

--$257.125 million taxable qualified school construction bonds (QSCBs), series 2010C;

--$151.06 million taxable Build America Bonds-Direct Payment, series 2010D;

--$10 million series 2010 E;

--$170 million refunding bonds, series 2010F; and

--$73.1 million taxable refunding bonds, series 2010G.

The series C, D and E bonds are expected to sell via negotiation the week of Oct. 11, 2010 and the series F and G are expected to sell the week of Oct. 18, 2010.

In addition, Fitch downgrades $4.9 billion in outstanding GO bonds to 'A+' from 'AA-'.

The Rating Outlook on all the bonds is Stable.


--The downgrade to 'A+' from 'AA-' reflects the Chicago Public Schools' (the district) weakened financial flexibility and expected continued challenges in the next several years in attaining stable financial operations given the diminution of non-recurring sources of budget relief.

--State aid payments continue to be delayed.

--Pension and debt service costs will rise significantly in fiscal 2014, further pressuring financial operations.

--The city of Chicago ('AA', Negative Outlook) benefits from a large and diverse economic base whose employment base and housing market are nonetheless under substantial stress.

--Debt levels are above average and expected to increase given the district's slow amortization and large capital plan.

--Student enrollment has somewhat stabilized.


--The district's ability to balance revenues and expenditures given high and escalating fixed costs with reduced use of non-recurring sources;

--Ability to adequately address and control rapidly rising retiree benefit costs;

--Maintenance of a manageable debt burden in light of the district's variable rate exposure, expiring liquidity facilities, and its sizeable capital plan;

--Stabilization in the local economy.


The bonds are alternate bonds payable from pledged general state aid revenues, and if insufficient, from unlimited ad valorem taxes levied against all taxable property in the City of Chicago.


The Chicago Public Schools is the nation's third largest school district serving over 400,000 students in 675 schools. Student enrollment after multiple years of 1-2% declines has stabilized as a result of reduced enrollment in private and parochial schools as residential incomes have become more strained. While the city is the economic engine of the state and benefits from a diverse tax and employment base, it has experienced significant jobs losses in the recession particularly in financial services and construction related employment driving the unemployment rate to a high 10.8% in August 2010. In addition, the city's housing market has suffered from high sub-prime mortgage exposure and above average foreclosure rates.

After several years of operating surpluses due in part to growing property tax receipts, the district's financial position weakened significantly beginning in fiscal 2009. Fiscal 2009 produced an operating deficit of $143 million in part due to $173 million in delayed categorical aid payments from the state, which continues to face severe budgetary pressures. The monies were eventually received after the close of the fiscal year but the state continues to lag in aid payments. Fiscal 2010 again proved difficult for the district, requiring significant cuts in spending which included layoffs and furlough days in the central office as well as the elimination of almost 1,300 teacher positions. Year end results are expected to show a second year of an operating shortfall of approximately $117 million, leaving an unreserved general fund balance of $190 million, or 3.6% of total expenditures and transfers out, well below the district's 5% minimum threshold. At year end 2010, the district was due $236 million from the state.

For fiscal 2011, the district projected a sizeable deficit of $1 billion on an operating budget of $6.5 billion. The gap was subsequently closed primarily with the use of multiple non-recurring actions including short-term pension relief of $400 million for each of fiscal 2011-2013 provided by legislative actions of the Illinois General Assembly in 2010, additional federal stimulus monies of $407 million, and the use of the $190 million fund balance which will now be replaced by the restructuring of 2011 and 2012 debt service payments and other available funds. The state is again behind in its aid payments, and Fitch expects that the delays will continue. While the district was able to close the large gap in 2011, Fitch believes that fiscal 2012 and beyond will be extremely challenging for the district. Federal stimulus programs are expected to expire at the end of 2011, the district will be facing large increases in its pension and debt service payments beginning in 2014, and there is uncertainty with respect to expiring teacher contracts which had previously provided generous annual wage increases of 4%. As the district has undertaken sizeable expenditure reductions including lowering staffing levels in 2010 and 2011, Fitch believes additional expenditure reductions may be difficult to obtain.

The board's overall debt burden, including overlapping entities, is high at $5,361 per capita and 5% of market value, and amortization is extremely slow at 31% in 10 years. Included in the district's debt portfolio is $725 million of variable rate bonds (16% of total debt outstanding), most of which is hedged with interest rate swaps. Debt levels are expected to increase significantly given the district's sizeable capital improvement program (CIP) of $1.7 billion. In addition, the current refunding structure extends the maturity of outstanding bonds in order to provide the district with debt service relief in fiscal years 2011 and 2012 of $200 million. Proceeds from the series 2010C, D and E will finance the district's 2009 and 2010 capital needs. Proceeds from series 2010 F and G will refinance a portion of the district's outstanding UTGO bonds. While the district's pension system was adequately funded at 74% as of June 30, 2009, the district continues to severely under-fund its actuarially required contribution (ARC) and with the payment deferrals in 2011 through 2013, future payments will increase significantly. The district's total actuarial liability to the Health Insurance Program for retiree health care is a significant $2.4 billion as of June 30, 2009, with an annual required contribution of $171.8 million. The district contributes to the fund on a pay-as-you-go-basis.

Contact: Primary Analyst, Ann Flynn, Senior Director, +1-212-908-9152, Fitch, Inc., One State Street Plaza, New York, NY 10004

Secondary Analyst, Amy Laskey, Managing Director, +1-212-908-0568, Committee Chairperson

Karen Krop, Senior Director, +1-212-908-0661, Additional information is available at ''.

In addition to the sources of information identified in Fitch's Tax-Supported Rating Criteria, this action was additionally informed by information from IHS Global Insight, the Underwriter, and Bond Counsel.

Related Research:

'Tax-Supported Rating Criteria', dated Aug. 16, 2010

'U.S. Local Government Tax-Supported Rating Criteria', dated Dec. 21, 2009

For information on Build America Bonds, visit ''.

Applicable Criteria and Related Research:

Tax-Supported Rating Criteria

U.S. Local Government Tax-Supported Rating Criteria



October 12, 2010 at 6:16 AM

By: Dan Schmidt

Downgrade is a real story

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