|[October 11, 2013]
Fitch Downgrades Philadelphia School District Underlying Rating to 'BB'; Outlook Remains Negative
NEW YORK --(Business Wire)--
Fitch Ratings downgrades to 'BB' from 'BBB-' the underlying rating on
the following bonds:
--$2.1 billion Philadelphia School District (the district) general
obligation (GO) bonds;
--$1.1 billion State Public School Building Authority (Commonwealth of
Pennsylvania) (The School District of Philadelphia Project) school lease
The Rating Outlooks for the underlying district and authority ratings
All of the bonds have an 'AA-' enhanced rating based on the Pennsylvania
School Credit Enhancement Direct-Pay Intercept Program (the program).
The Rating Outlook for the program is Negative, reflecting the Negative
Outlook on the Commonwealth of Pennsylvania's GO bonds.
All of the bonds are secured by protections under the Pennsylvania
School Credit Enhancement Law as well as the district's full faith and
credit and taxing power.
KEY RATING DRIVERS
WEAKENING UNDERLYING CREDIT PROFILE: The downgrade of the underlying
rating largely reflects the continued deterioration of the district's
already tenuous financial position.
UNCERTAIN PROJECTIONS: The district's plans to achieve structural
balance rely heavily on its continued ability to achieve dramatic
expenditures savings, particularly gaining significant negotiated
concessions from the teacher's union. Fitch believes the level of
cooperation needed to fully realize these plans will likely not be
forthcoming, resulting in continued negative operations and increased
LIMITED ABILITY TO RAISE REVENUE: Fifty-seven percent of the district's
funding is tied to state sources, and raising locally generated revenue
requires state and city council approval.
ELEVATED DEBT LEVELS: The district's overall debt burden is high
relative to the tax base, although annual debt service expenditures
consume a moderate share of the district's operating budget. Payments
for other long-term liabilities are modest but growing.
STABLE SERVICE AREA: Demographic and economic indicators are weak,
although the city's economy is anchored by the presence of several large
healthcare and higher education institutions.
SOUND INTERCEPT PROGRAM: The enhanced, programmatic 'AA-' rating is
based on Pennsylvania School Credit Enhancement Direct-Pay Intercept
Program (Intercept Program) state law, which requires the withholding of
state appropriations and their direct payment to bondholders or their
SOLID COVERAGE: For fiscal 2014, budgeted commonwealth subsidies to the
district cover annual debt service obligations, including short-term
debt, by 3.45 times (x), above the 1.25x required for eligibility under
Fitch's criteria for the use of this intercept program's rating.
Coverage has increased over past levels due to a reduction in the
district's short-term debt.
COST-CUTTING PLAN IMPLEMENTATION: Failure to implement the additional
level of cost-cutting measures needed to avoid further deterioration in
its financial position would likely lead to a further downgrade.
LARGE URBAN DISTRICT WITH WEAK SOCIOECONOMICS
The Philadelphia School District is the nation's eighth largest school
district and the largest in the commonwealth, with a fiscal year 2013
enrollment of 203,000 students. District enrollment has shown growth in
recent years primarily because charter school enrollment continues to
escalate at a healthy rate each year, with a current population of
63,600. Non-charter school enrollment has declined fairly rapidly.
As both a city and county and with an estimated population of almost 1.5
million residents, Philadelphia benefits from its role as a regional
economic center with a stable employment base weighted in higher
education and health care sectors. Led by the University of
Pennsylvania, Jefferson Health System and Temple University, the city is
home to several large colleges and universities and is anchored by
multiple hospitals and health systems.
The city's July 2013 unemployment rate of 10.8% remains high as does the
poverty rate at over 25% of the population. Income levels on both a per
capita and median household level are well below the state and national
DEFICITS REFLECT STRUCTURAL IMBALANCE
Fiscal 2012 continued the trend of negative performance begun in fiscal
2010, with the unrestricted fund balance declining to negative $136.8
million. The district benefited from a $95 million increase in funding
from the city through a 3.5 mill property tax increase. However, this
was not enough to offset a $200 million decrease in state funding.
Management cut spending extensively to help offset these revenue
declines, including over $318 million of cuts to schools and $63 million
of reductions in the centraloffice. Reductions also included several
non-recurring measures, such as refinancing debt to delay debt service.
DEFICIT FINANCING OFFSETS LARGE FISCAL 2013 OPERATING DEFICIT
Unaudited fiscal 2013 results show a cash basis operating deficit of
over $250 million, driven largely by increases in debt service payments
following fiscal 2012 restructurings, and payments to charter schools.
Increased charter school enrollment has caused financial pressure for
the district, and Fitch expects this trend to continue. Results would
have been even weaker without a favorable outcome in the district's
negotiations with its blue collar unions. The district bridged the $250
million operating gap with the issuance of deficit bonds, generating
$300 million in proceeds and yielding a surplus of approximately $52
million or a cash-basis fund balance of $33 million. Fitch anticipates a
continued very large accumulated deficit on a GAAP basis.
FIVE-YEAR PLAN DEPENDS ON (News - Alert) LABOR SAVINGS AND CLOSINGS
The district's fiscal 2014 budget assumes the depletion of its $33
million cash-basis fund balance. The budget avoided a cash deficit
largely through the closure of 24 schools and layoff of 2,400 mostly
part-time workers. The district laid off 4,000 workers this summer, but
hired back over 1,600 when additional funds were identified to open
The district reached an agreement in 2012 with the Service Employees
International Union (SEIU) that will provide $100 million in savings
over the four year life of the contract, largely from an approximately
10% reduction in wages. The district's contract with the Philadelphia
Federation of Teachers (PFT) expired in August 2013, along with the
principals (CASA) and two smaller unions representing cafeteria works
and school police. The district is seeking concessions from PFT similar
to those reached with SEIU, with corresponding budgeted savings of $118
million-$155 million per year. These savings were not incorporated in
the fiscal 2014 budget but are reflected in the district's five-year
plan. PFT is not legally permitted to strike and is somewhat limited in
its negotiating leverage because the district is a 'distressed'
district. However, Fitch believes the district will be hard-pressed to
achieve the level of savings it has projected.
The district is anticipating additional funding from the city and state.
The state has agreed to provide the city with $45 million of additional
aid, on the condition that it sees progress in negotiations with PFT.
Additionally, the city expects to provide $50 million in aid by
borrowing against future sales tax receipts. However, the mechanism for
this payment has not yet been agreed upon. The funds are anticipated to
cover the rehiring of the 1,600 employees at the start of the school
year. The current plan for the extension of the sales tax would also
provide the district with an additional $120 million per year of sales
tax revenue beginning in fiscal 2015. The state has agreed to advance
the district payments it normally receives later in the year, reducing
the district's need for cash flow borrowing from its $500 million issue
in fiscal 2013 to $125 million in fiscal 2014.
ELEVATED DEBT LEVELS
Overall debt ratios are above average at over $4,900 per capita and a
very high 17.3% of market value. The market value ratio is overstated
due to antiquated property assessment practices, which the city recently
updated. Based on the city's revised market value, debt would still be a
high 6.5% of market value. Amortization is slightly below average at
approximately 41% in 10 years, though amortization was slowed by recent
The district will be faced with a more than doubling of pension costs
from fiscal 2012 to fiscal 2017. This growth is factored into the
district's five-year plan, though it is hoping for relief from the state
as the state pursues pension reform. The district participates in a
state-sponsored plan with approximately 70% being met by the state. The
plan is currently approximately 63% funded using a Fitch-adjusted 7%
return level, and the funding level has been deteriorating as the state
has consistently underfunded its annual required contribution. Other
post-employment benefits are minimal. Carrying costs are a moderate
10.5% of governmental spending, though this is expected to grow with
increased pension costs.
Additional information is available at 'www.fitchratings.com'.
In addition to the sources of information identified in the
Tax-Supported Rating Criteria, this action was additionally informed by
information from Creditscope, University Financial Associates,
S&P/Case-Shiller Home Price Index, IHS (News - Alert) Global Insight, Zillow.com,
National Association of Realtors, and Bond Counsel.
Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria' (Aug. 14, 2012);
--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 14, 2012).
--'U.S. State Government Tax-Supported Rating Criteria' (Aug. 14, 2012).
--'Rating Guidelines for State Credit Enhancement Programs' (Apr 18,
--'Fitch Downgrades Pennsylvania's GO Bonds to 'AA' from AA+'; Outlook
Remains Negative' (July 16, 2013).
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
U.S. Local Government Tax-Supported Rating Criteria
U.S. State Government Tax-Supported Rating Criteria
Rating Guidelines for State Credit Enhancement Programs
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