OREANDA-NEWS. Fitch Ratings has assigned an 'A+' rating to the following bonds issued for the school district of Philadelphia (the district) based on the Pennsylvania School Credit Enhancement Direct-Pay Intercept Program:

--\$63.745 million State Public School Building Authority (Commonwealth of Pennsylvania) (the authority) school lease revenue refunding bonds (the school district of Philadelphia project) series 2015A.

Additionally, Fitch Ratings has assigned an 'A+' rating to the following bonds issued for the district based on the Pennsylvania School Credit Enhancement Intercept Program:

--\$46.15 million school district of Philadelphia general obligation (GO) bonds series A of 2015;
--\$29.165 million school district of Philadelphia GO refunding bonds series B of 2015;
--\$45.12 million school district of Philadelphia GO refunding bonds series C of 2015;
--\$130.175 million school district of Philadelphia GO refunding bonds series D of 2015.

The bonds are scheduled to be sold via negotiated sale the week of Feb. 16. The series D bonds will have a delayed delivery date. Proceeds will be used to refund certain outstanding bonds and pay for various capital projects.

Concurrently, Fitch assigns an underlying rating of 'BB-' to the series 2015 bonds and affirms this rating on approximately \$3 billion of the district and authority's outstanding bonds.

The Rating Outlooks for the commonwealth's programs are Stable, reflecting the Stable Outlook on the commonwealth's GO bonds. The Rating Outlooks for the underlying district and authority ratings remain Negative.

SECURITY

The bonds issued by the authority are special limited obligations of the authority. For these bonds, payments from the State Treasurer are made directly to the Trustee on the last Thursday of April and October of each year, in advance of debt service payments on June 1 and Dec. 1. The district has covenanted that it will include in its budget appropriations for payments to the authority. For these payments, the district irrevocably has pledged its full faith, credit and taxing power. All of the authority and GO 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

WEAKENED UNDERLYING CREDIT PROFILE: The district continues to experience weakening to its already tenuous financial position.

UNCERTAIN RECOVERY PROSPECTS: The district's plans to achieve structural balance rely heavily on its continued ability to implement dramatic expenditures savings, particularly gaining significant 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 accumulated deficits.

RAPID CHARTER SCHOOL GROWTH: The number of students enrolled in charter schools has almost doubled in the past four years. Further growth is expected, increasing the challenges of the district's financial environment.

LIMITED ABILITY TO RAISE REVENUE: As is typical for school districts, the largest source of funding is from the state. Raising locally generated revenue requires city council approval. The state's increasingly challenged financial position limits the likelihood of increased state aid unless the state secures new revenues sources to stabilize its finances. The recent addition of a dedicated cigarette tax was a positive step.

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 moderate 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 AUTHORITY INTERCEPT PROGRAM: The enhanced, programmatic 'A+' rating for the authority bonds is based on the Pennsylvania School Credit Enhancement Direct-Pay Intercept Program. This program requires the withholding of state appropriations and their direct payment to bondholders or their paying agents.

SOLID COVERAGE FOR GO BOND INTERCEPT PROGRAM: The enhanced, programmatic 'A+' rating for the GO bonds is based on the Pennsylvania School Credit Enhancement Intercept Program under state law. This program requires the state to pay a sinking fund deficiency from any unpaid state appropriation to the district upon notification of a deficiency 15 days prior to a debt service payment date. For fiscal 2014, budgeted commonwealth subsidies to the district covered annual debt service obligations, including short-term debt, by 2.38 times (x). This exceeds the 1.25x required for eligibility under Fitch's criteria for the use of this intercept program's rating.

RATING SENSITIVITIES

FURTHER FINANCIAL DETERIORATION: Additional reductions in financial flexibility over the medium term due to an inability to make at least modest progress in stemming operating deficits would lead to a further downgrade.

CREDIT PROFILE

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 fiscal year 2015 enrollment of 207,000 students, including charter school students. District enrollment has shown growth in recent years primarily because charter school enrollment continues to escalate at a healthy rate. The current population of 64,000 is almost double the fiscal 2010 level. Non-charter school enrollment has declined fairly rapidly. The district is overseen by an appointed School Reform Commission (SRC).

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.

Though well down from past levels, the city's November 2014 unemployment rate of 6.4% remains high as does the poverty rate at over 26% of the population, though unemployment is well down from past highs. Income levels on both a per capita and median household level are well below the state and national averages.

DEFICIT FINANCING OFFSETS LARGE FISCAL 2013 OPERATING DEFICIT

Fiscal 2013 results showed an operating deficit of almost \$250 million across the district's three operating funds. The deficit was 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. The \$300 million in proceeds yielded a surplus of \$59 million but were not sufficient to eliminate the accumulated unrestricted fund deficit, which stood at -\$63 million or -2% of expenditures at fiscal year-end.

FISCAL 2014 CONTINUES NEGATIVE OPERATIONS

Preliminary fiscal 2014 results show a further operating deficit, with an estimated \$55 million decline in fund balance, worse than the budgeted \$39 million deficit and reducing the unrestricted fund balance to -\$110 million or -4% of expenditures. The district closed 24 schools and laid off 3,800 employees before hiring back almost 1,900 when some funding was restored. The deficit was exacerbated by further increases in payments to charter schools and revenues from building sales coming in under budget.

PLAN DEPENDS ON LABOR SAVINGS AND OUTSIDE AID

The district's fiscal 2015 budget was balanced through a number of measures. The district laid off over 300 employees. A one percent sales tax previously directed to the city was extended, with the first \$120 million going to the district, and a \$2 per pack cigarette tax within the city was enacted several months into the fiscal year, estimated to generate \$49 million in fiscal 2015. District officials note that these efforts bring them to a bare minimum service level, and are seeking significant additional funding to provide better educational opportunities. For the second consecutive year the state advanced the district some of its annual funding, helping the district to bridge its cash flow gap and reduce its short-term borrowing needs.

The district reached an agreement in 2012 with the Service Employees International Union (SEIU) that provides \$100 million in savings over the four year life of the contract, largely from an approximately 10% reduction in wages. In 2014 the district also reached agreement with its administrators for a new contract that includes 12 - 16% pay cuts, a shorter work year, and increased health care contributions, netting \$20 million a year in savings.

The district's contract with the Philadelphia Federation of Teachers (PFT) expired in August 2013. For some time, the district was requesting large wage cuts similar to those agreed to by SEIU, but the two sides could not reach an agreement. PFT is not legally permitted to strike. In October, 2014, the SRC cancelled the union's existing, expired contract and attempted to impose changes in health care benefits, require employee contributions to health care benefits, and eliminate an existing health and welfare fund. This would have saved the district approximately \$50 million a year. The Commonwealth Court recently ruled that the SRC's actions were not legal. The SRC is currently evaluating whether to appeal the ruling.

ELEVATED DEBT LEVELS

Overall debt ratios are above average at over \$4,500 per capita and a high 6.1% of market value. Amortization is slightly below average at approximately 48% in 10 years.

The district will be faced with an almost doubling of pension costs from fiscal 2015 to fiscal 2019. The district is hoping for relief as the state may pursue pension reform. The district participates in a state-sponsored plan with approximately 67% of employer contributions made by the state. The plan is currently approximately 60% 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 (ARC). The increased costs are partially caused by the plan shifting towards full funding of the ARC by 2017, which Fitch views favorably. Other post-employment benefits are minimal. Carrying costs are a moderate 16% of governmental spending, though this is expected to grow with increased pension costs.