OREANDA-NEWS. March 23, 2015. Fitch Ratings has assigned a 'BBB-' rating to the following Chicago Board of Education, IL (the board) unlimited tax general obligation (ULTGO) dedicated alternate revenues bonds:

--\\$89.2 million refunding bonds series 2015A;
--\\$175.675 million series 2015C project bonds;
--\\$100 million series 2015D project bonds (mandatory put bonds);
--\\$20 million series 2015E project bonds (green bonds);
--\\$76.545 million series 2015F refunding bonds;
--\\$88.9 million refunding bonds series 2015G.

The bonds are scheduled for negotiated sale the week of March 23. Proceeds will be used to refund outstanding bonds and fund portions of the board's capital plan.

In addition, Fitch downgrades to 'BBB-' from 'A-' the rating on approximately \\$5.6 billion of the board's ULTGO bonds.

The Rating Outlook remains Negative.

SECURITY

The bonds are general obligations of the board to the payment of which the board will pledge its full faith and credit. Most of the bonds are payable from pledged state aid. In those cases, to the extent that pledged state aid revenues are insufficient to pay debt service, the bonds will be payable from ad valorem taxes levied by the board, without limitation as to rate or amount, against all of the taxable property in the city of Chicago. The pledge of state aid revenue does not provide any enhancement to the rating.

KEY RATING DRIVERS

CONTINUED FINANCIAL STRESS: The downgrade reflects the limited progress the Chicago Public Schools (CPS) has made in addressing a structural budget gap approximating 20% of spending for the upcoming fiscal year. Following substantial drawdowns in the prior and current fiscal years, reserves will likely to be fully depleted by the end of fiscal 2016.

NEGATIVE OUTLOOK MAINTAINED: Substantial changes are necessary to support ongoing operating and fixed cost spending. Options within the board's sole control are limited and Fitch believes meaningful solutions would have a notable impact on educational programs.

CASH FLOW DRAIN: Liquidity levels have been diminished considerably and are likely to require a significant infusion of short-term borrowing in fiscal 2016, even if the majority of the budget gap is closed.

PENSION LIABILITY WEAKNESS: Large pension liabilities were exacerbated by a three-year payment deferral that caused a dramatic jump in annual contributions beginning in fiscal 2014. Absent pension reform, the liability is likely to remain quite high.

POOR LABOR HISTORY: Fitch believes the contentious settlement of the last contract negotiation with the Chicago Teacher's Union (CTU) in 2012 may pose challenges for upcoming contract negotiations.

ECONOMY RECOVERING SLOWLY: Chicago benefits from a large and diverse economic core that has shown gradual signs of improvement.

UNFAVORABLE DEBT POSITION: The district's debt levels are above average with very slow amortization. Expectations are for moderate future debt issuance.

RATING SENSITIVITIES

REVERSING STRUCTURAL IMBALANCE: Fitch will downgrade the rating further if there is not clear and meaningful progress in reducing the large structural imbalance. The implementation of a sustainable plan to achieve balance could result in a Stable Outlook.

MOUNTING FIXED COSTS: A notable increase to debt or unfunded post-employment liabilities would also likely result in a rating downgrade.

CREDIT PROFILE

CPS serves almost 400,000 students in 664 schools in school year 2014-2015 in a district that is coterminous with the city. Enrollment trends are slowly declining.

LIMITED OPTIONS TO ADDRESS LARGE BUDGETARY GAPS
Fitch believes the size of the operating shortfalls in fiscal 2014 and 2015, and the magnitude of the gap in fiscal 2016, underscore the difficulty of making meaningful progress in balancing operations. CPS projects an \\$862 million (15%) general fund gap for fiscal 2015 despite implementation of a far-reaching and controversial school closure plan, an increase in property tax revenues to the statutory cap, sizable reductions in non-education spending, and continued pressure on the state for pension reform.

The district expects fiscal 2015 to end close to budget, with reserves of about \\$300 million (roughly 8% of spending) in the general fund and \\$140 million in the debt service fund. This follows a drawdown in fiscal 2014 of \\$513 million (9.4% of spending). Absent a change in the property tax accrual period to 60 days (which Fitch believes is standard) from an aggressive 30 days, the ending unrestricted fund balance would have stood at \\$354 million (6.5% of spending). On an adjusted basis, management anticipates a \\$1 billion ending fund balance. Property taxes make up about 44% of total revenue.

Management's efforts to reduce costs have yielded some savings, including school closures as well as central office and other administrative spending. Management has attempted to avoid cuts to classroom spending. Additional savings in these areas appear to be limited.

Fitch believes the 2012 CTU strike made apparent the poor working relationship between the board and the CTU. Absent improvement, upcoming labor negotiations are likely to be challenging. The contract extends through June 30, 2015 unless extended at CPS's option, with CTU approval. CTU represents about 74% of board employees.

GAP GROWS IN FISCAL 2016
The board's projections show a budget gap of over \\$1 billion for fiscal 2016, or about 20% of spending. Some of management's proposed solutions include pension reform, the impact and timing of which are uncertain. Pension reform is largely dependent on approval by the state, and would have a material but far from complete impact on the deficit both in fiscal 2016 and going forward.

LIQUIDITY CONCERNS
Even with significant spending cuts, the district will be highly dependent on short-term borrowing to maintain positive cash flow. Liquidity declined dramatically from \\$1.1 billion of cash at the close of fiscal 2013 to \\$109 million a year later. The decline in cash was exaggerated by the use of cash to pay for projects that are being reimbursed by this bond issue and the acceleration of vendor payments that were partially reimbursed in fiscal 2015.

Given the size of budget gaps for the current and upcoming fiscal years, Fitch believes a continued slide in liquidity is likely. The district's largest revenue source is property taxes, which made up about 44% of fiscal 2014 revenues.

PENSION LIABILITIES CONSISTENT WITH WEAK REGIONAL NORMS
Pension funded ratios dropped significantly in the last several years due to a combination of lower-than-expected investment returns and payment deferrals for the CTU plan granted by the state for fiscal years 2011-2013. As of June 30, 2014 the plan was 52% funded, or approximately 48% using a 7.75% return rate, up slightly from the prior year but way down from 80% and 72%, respectively, in fiscal 2008. The unfunded actuarial liability totaled \\$9.5 billion in fiscal 2014, up over 200% since fiscal 2008. District non-teachers participate in even more poorly funded city plans, though recent reform to those plans should gradually improve funding levels. CPS is not required to contribute to these other plans.

The increased pension payment beginning in fiscal 2014 of \\$613 million over \\$208 million in fiscal 2013 was needed to bring payments up to the level required to increase the CTU plan's funded ratio to 90% by fiscal 2059. Fitch does not believe this is an aggressive goal with respect to addressing the unfunded liability but still expects the district will be challenged to meet it. The contribution increased to \\$697 million in fiscal 2015 but will decline slightly in fiscal 2016 and 2017. Fitch is concerned about not only these plans but other city, Cook County, and State of Illinois plans which are all poorly funded.

HIGH DEBT, SWAP TERMINATION TRIGGERED BY DOWNGRADE
The district's overall debt levels are high at 9.5% of market value, with slow amortization of 29% in 10 years, the result of long-dated debt and restructurings. Fitch views positively a reduction in variable rate debt to 17% from 49% in the last several years, although the current ratio is still above norms for the sector.

The district has outstanding swap agreements with a mark-to-market of -\\$263 million as of March 2, 2015. Additional termination events occur if two of CPS's ratings fall below 'BBB'/'Baa2'. CPS is currently rated 'Baa3' by Moody's, so the current downgrade by Fitch will trigger a termination event. In order to avoid a termination payment, Fitch believes the district will have to either renegotiate the terms of the swaps with the counterparties or bond for the funds, as cash balances appear inadequate to cover both termination payments and operations.

Other post-employment benefits (OPEB) are similarly underfunded but annual payments are capped at \\$65 million. Carrying costs including the full payment of the actuarially required contribution are currently estimated to be a moderate 19%. Costs will likely stay relatively controlled due to the slow amortization of the pension obligation.

ECONOMY SHOWING SOME IMPROVEMENT
Chicago ('A-', Outlook Negative) serves as the economic and cultural hub for the Midwest region, and maintains good prospects for long-term stability if not growth. The city has gained almost 50,000 jobs since 2010 primarily in professional and business services despite reductions in both manufacturing and public service. Chicago's population totaled 2.7 million in 2014, down 6% from the 2000 census, but still accounts for 21% of the state's population.

Socioeconomic indicators are mixed with elevated unemployment and individual poverty rates, average per capita income levels, but strong educational attainment levels. As of December 2014, the city's unemployment rate was 6.2%, down from 9.5% a year earlier. Employment during this period was up 3.3%.