Chicago Public Schools Fiscal Year 2017 Budget

Debt Management

Chicago Public Schools’ (CPS) Capital Improvement Program, described in the Capital chapter, each year funds a variety of investments such as relieving overcrowding, playgrounds, air conditioning, expanded bandwidth and new computers, and core investments in our facilities to repair or replace infrastructure and mechanical systems. This work creates a high quality learning environment to support a high quality education.

CPS funds the Capital Improvement Plan largely through the issuance of bonds.  Bonds are debt instruments that are similar to a loan, requiring annual principal and interest payments. Most of these bonds are repaid from General State Aid (GSA) revenues. Since GSA is also a major revenue source for core academic priorities, we face a continuing challenge in balancing the day-to-day classroom needs with the need for quality educational facilities. 

Debt Overview

As of June 30, 2016, the Board of Education has $6.7 billion of outstanding long-term debt and $870 million of outstanding short-term debt.  FY17 includes appropriations of $563 million for alternate bonds and PBC payments.  

CPS continually reviews the affordability of its capital program, minimizes debt issuance costs and monitors existing debt for any cost-saving opportunities as part of its efforts to meet budget challenges. Because of the size of the operating budget gap and the significant financial challenges facing the district, CPS has significantly reduced its capital plan and as a result the debt service associated with funding those projects. 

Debt Profile

CPS has established the following debt management goals to balance costs, risks and liquidity needs:

• To terminate swap agreements and reduce the District’s reliance on scoop-and-toss borrowing
• To borrow at the lowest cost of funds available in the market and balanced against acceptable risk levels
• To maintain an appropriate allocation of debt products and to refinance existing debt, given market access and conditions
• To maintain the strongest credit ratings possible, given current financial constraints
• To fund a capital plan that balances the need for new construction with the affordability of additional debt issuance 

Types of Obligations

The Board is authorized by state law to issue notes and bonds and to enter into lease agreements for capital improvement projects.  CPS issues Alternate Revenue General Obligation Bonds.  As with most school districts, CPS issues bonds backed by the full faith and credit of the Board, otherwise known as General Obligation (GO) Bonds.  These GO bonds are paid for from all legally available revenues of the Board. 

CPS issues a special type of GO bond called an “Alternate Revenue” GO Bonds.  These bonds are backed by two revenue sources and offer a number of other bondholder protections.  The first revenue source is a property tax levy which is available to support debt service should the Alternate Revenue not be available.  In addition to the property tax levy, CPS uses “Alternate Revenues” to repay its bonds (e.g. GSA).  With these revenues available to pay debt service, the property tax can be and is abated every year.  As a result, CPS bonds have two dedicated revenue sources, property taxes and the specific alternative revenue, which provide an additional layer of security for bondholders.  The Board is authorized to issue Alternate Revenue Bonds after adopting a resolution and satisfying public notice publication and petition period requirements in lieu of a voter referendum, which is typical in other school districts.  The bonds are also supported by the General Obligation pledge of the Board that it will use all legally available revenues to pay debt service.

The Alternate Revenues supporting CPS bonds are GSA, Personal Property Replacement Taxes (PRRT), revenues derived from intergovernmental agreements with the City of Chicago, property taxes and federal interest subsidies. The majority of CPS bonds are backed by GSA.  In FY17, $373 million in GSA revenues will be required for debt service.  CPS also anticipates using $20 million of the Debt Service Stabilization Fund to reduce GSA needed to fund debt service and help reduce the impact of debt service on the operating deficit. 

In addition to debt service funded by GSA, $58 million of debt service is paid from PPRT.  Debt service paid from PPRT revenues also reduces PPRT revenues available for operating purposes.  Additionally, $96 million in debt service is paid by revenue resulting from Intergovernmental Agreements with the City of Chicago.

The Public Building Commission (PBC), a local government entity which manages construction of schools and other public buildings, has in the past sold bonds which rely on CPS property tax levies. No PBC bonds have been issued since 1999 and these bonds expire in 2020.  The FY16 budget includes $52 million in payments for principal and interest on these bonds. 

CPS has benefitted from issuing bonds with federal interest subsidies, resulting in a very low cost of borrowing.  These include Qualified Zone Academy Bonds (QZABs), which provide capital funding for schools in high-poverty areas, Qualified School Construction Bonds (QSCBs), and Build America Bonds (BABs), the latter two created by the American Recovery and Reinvestment Act of 2009 (ARRA).  With the expiration of ARRA, new QSCBs and BABs are no longer available, although the federal government continues to pay the interest subsidy to CPS.  The FY16 budget includes $25 million of federal subsidies for debt service.

As a result of the passage of PA 98-0018 in June 2013, CPS began annually receiving State School Infrastructure Fund monies as part of the State School Construction Program.  CPS received approximately $13.3 million in FY15.  CPS anticipates it will continue to receive approximately $13.3 million annually.  Revenues are being applied toward the funding of the construction of new schools and other projects.  If needed, CPS can issue debt to be paid for from these revenues.

In FY16, a capital improvement property tax was levied in the amount of $45 million.  CPS expects to be able to use these revenues to either fund capital projects or debt service for bonds used to fund capital projects.  This levy is allowed to grow at CPI annually and steps up by $143 million in FY2032. CPS is exploring ways to maximize revenue from the CIT.

Debt Management Tools and Portfolio Mix

As part of the Debt Management Policy, CPS is authorized to use a number of tools to manage its debt portfolio including refunding of existing debt, issuing fixed or variable-rate bonds, and issuing short-term or long-term debt. These tools are used to manage various types of risks, to generate cost savings, to address interim cash flow needs and to assist capital asset planning. 

Typically, CPS issues fixed-rate bonds which pay a set, agreed upon interest rate according to a schedule established at the time of debt issuance.  However, about 16 percent of CPS’s debt is variable rate, which means that the interest rate is not set and can fluctuate. 

Chart 1: Summary of Fixed Rate and Variable Rate Debt
(as of June 30, 2016)

Additionally, the Board entered into 10 interest rate swaps from 2003 to 2007.  An interest rate swap is an agreement between two parties (known as counterparties) where one stream of future interest payments is exchanged for another based on a specified principal amount.  The Board’s swaps generally convert the variable rate paid to bondholders to a fixed rate through the exchange of interest payments with its counterparties.  No swaps have been entered into since 2007 and the district has no intention to use swaps going forward.

In March 2015, each of Moody’s Investor Service, Standard & Poor’s Rating Service and Fitch Ratings downgraded the long-term credit of the Board to below investment grade.  Once two long-term ratings of the Board were below the equivalent “Baa2”/”BBB”/”BBB” by Moody’s, Standard and Poor’s and Fitch respectively, this began to trigger certain defaults, additional termination events and increases to interest rate charges in connection with the Board’s various interest rate swap agreements, lines of credit, loans, variable rate debt and letters of credit.   

As of March 2015, when termination events were triggered on the majority of the Board’s swaps, the estimated termination value of the total swap portfolio was $275 million.  The total amount of termination payments made by the Board in connection with the swap terminations was $234 million, of which $142 million was paid from the Board’s Debt Service Stabilization Fund and $86.4 million was paid from the proceeds of the Board’s 2015B TAN.  The reduction in the termination payment of the $40 million resulted from the Board’s negotiations with the swap counterparties for below market termination payments as well as improved market performance.  As of December 3, 2015, the Board terminated all ten of its previously outstanding interest rate swaps.

Credit Ratings

The Debt Management Policy of CPS provides guidance for debt management as well as capital planning and supports the Board’s ability to manage its debt in a conservative and prudent manner.  One of the goals of the policy is to ensure that CPS maintains the highest possible credit rating among the credit agencies. These agencies are independent entities and their purpose is to give investors, or bondholders, an indication of the creditworthiness of a government entity.  A high credit score can lower the cost of debt issuance, much the same way a strong personal credit score can reduce the interest costs of loans and credit cards.  Ratings consist of a letter “grade”, such as A, BBB, BB or B, and a credit “outlook”, or expectation of the direction of the letter grade.  Thus, a “negative outlook” anticipates a downgrade to a lower letter grade, a “stable outlook” means the rating is expected to remain the same, and a “positive outlook” may signal an upgrade to a higher, better rating.

CPS meets frequently with the credit rating agencies about its budget, audited financial results, debt plan, and management initiatives to ensure the agencies have the most updated information possible.  The primary rating factors for CPS concern management, debt profile, financial results and economic and demographic factors.

CPS’s current credit ratings from Standard and Poor’s, Fitch Ratings, Moody’s Investor Service and Kroll Bond Rating Agency (added in FY15)  are  B+, B+, B2, BBB, respectively.  All rating agencies hold CPS on a negative outlook.  Just as a high credit ratings can mean lower borrowing costs, deterioration in credit ratings due to the continuing budget deficits have started to lead to an increase in interest expenses for CPS. 

FY17 Challenges

FY17 presents a challenging environment for CPS to maintain ratings and issue bonds.  CPS faced a series of downgrades in FY16 due to challenges surrounding State funding, CPS’ continued drawdown on reserves, and limited ability to raise revenues.  These downgrades increase CPS’ cost of borrowing, further increasing revenues needed to pay debt service.  CPS continues to advocate for long-term funding solutions with our partners in Springfield. In addition to stable funding, this will also likely improve CPS’ ability to access the capital markets.

Additionally, as CPS continues to issue debt to invest in the District’s facilities, debt service will rise annually.  Because CPS funds its debt from GSA, each additional dollar of debt service reduces GSA dollars available for the classroom.  In FY17, approximately $373 million of GSA is required to fund debt service, representing 47 percent of the district’s unrestricted GSA.  By 2021, $467 million of GSA will be required to fund debt service, or 58 percent of unrestricted GSA.   The percentage of GSA used for debt service is slightly lower this year as compared to previous years due to the $102M increase in GSA funding provided by the State.  Similarly, approximately $58M (in FY16 through FY20) of Replacement Taxes are used for debt service, revenues that would otherwise be available for operating purposes.

In FY17, the budget assumes that CPS will use approximately $20 million of one-time transfer from the Debt Service Stabilization Fund (DSSF) to pay for debt service on bonds.  This reduces the amount of operating dollars necessary to cover debt service. 

In previous years, CPS received a modest amount of state revenues for school construction through the state’s School Construction Program to offset the amount of GSA needed for debt service.  In FY15, $59 million of these revenues were applied toward the repayment of existing debt and helped to increase the amount of GSA available for operating purposes.  In FY16, no state School Construction revenues were available to offset GSA-funded debt service and none are expected for FY17.   

The draw down on reserves and fund balance to help support the operating fund presents liquidity challenges as discussed in the Cash Management Chapter.  In order to provide sufficient liquidity to cover daily operating expenses, CPS will issue working capital lines of credit.  These working capital lines of credit are issued as Tax Anticipation Notes (TANs) which are repaid from property taxes.  The pending line of credit will be repaid from the 2016 tax year which is collected largely in FY17. 

FY16 Debt Service Costs

As shown in the table below, FY17 includes total appropriations of $563 million for alternate bonds and PBC payments.

CPS is required to set aside debt service a year in advance for GSA funded debt and one-and-a-half years in advance for PPRT funded debt service.  These payments are held in trust with an independent trustee, as required by the bond indentures.  Therefore, the FY16 Revenues shown for the Debt Service Funds represent the amount that is to be set aside for these future debt payments.

Because of this set-aside requirement, the majority of the appropriations for FY17 represent the amount that is to be paid from revenues set aside in the prior year. Table 1 provides information on the debt service fund balance at the beginning of the year, the expenditures that are made from the debt service fund and the revenues that are deposited to the fund to largely fund the debt service requirements for the following fiscal year. 

Table 1: FY15-17 Summary of Debt Service Funds
(In Millions)

Future Debt Service Profile

GSA and PPRT revenues needed to pay bondholders are in direct competition with resources needed to ensure we continue to fund priorities that drive academic achievement.  GSA and PPRT revenues needed to fund debt increases significantly from $373 million in FY16 to $467 million in FY21.

The following graph illustrates the fiscal challenges of CPS’s debt obligations on currently outstanding bonds.  This graph does not show the impact of any future bonds required to support future capital budgets or debt restructuring.

Measuring Debt Burden

External stakeholders such as taxpayers, unions, parents, government watchdog groups, rating agencies, and bondholders frequently review CPS’s debt profile to gauge its size and structure as a crucial component of CPS’s financial position.  In addition to evaluating the total amount of debt outstanding and the annual debt service payments, those evaluating CPS’s financial picture also look at our “debt burden.” The purpose is to gauge how much taxpayers bear in debt costs and determine how much debt is affordable for residents, which establishes true debt capacity.  Several methods of measuring debt burden are commonly employed for school districts; these include comparing existing debt to legal debt limits, measuring debt per capita and measuring debt as a percentage of operating expenditures.

Legal Debt Limit
The Illinois School Code imposes a statutory limit of 13.8 percent on the ratio of the total outstanding property tax-supported debt that a school district may borrow compared with a school district’s equalized assessed value, which generally represents a fraction of total property value in the district.  Because the Board has issued alternate revenue bonds for which property tax levies are not extended, these bonds do not count against the legal debt limit imposed by the Illinois School Code.  Therefore, total property tax supported debt is extremely low at less than 1 percent of the legal debt limit.

Debt Per Capita
The Board’s per capita debt burden, or total debt divided by the City of Chicago’s population, has increased in the last decade.  As reported in the FY15 Comprehensive Annual Financial Report, general obligation debt per capita in FY15 is $2,252. This is still considered moderate to slightly above average relative to other comparable school districts.

Debt as a Percent of Operating Expenditures
Another way of measuring the total debt burden is by dividing annual debt service expenditures by operating fund expenditures. Based on this method, the debt burden for FY15 and FY16 are estimated at 9.1 and 11.1 percent of total operating expenditures respectively, reflecting the increased debt burden as a result of recent bond issues.

A copy of the Debt Management Policy is available at the Board’s website at http://policy.cps.k12.il.us/download.aspx?ID=42

Outstanding Debt
as of June 30, 2016

*Excludes accreted interest accrued on 0% coupon capital appreciation bonds, short-term line of credit and $150,000,000 par amount of Series 2016B Bonds that were issued after 6/30/16.

Schedule of Debt Service Requirements to Maturity*
as of June 30, 2016
($ in Thousands)

* Excludes $150,000,000 par amount of Series 2016B Bonds that were issued after 6/30/16.