State law, new management turn pipe dream into reality

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Two years ago, the notion that the School Board would be selling $850 million in bonds to rehab schools and relieve overcrowding would have been a pipe dream.

As the front-page headline in Catalyst’s April 1995 issue warned: “No money in sight to relieve overcrowding.”

But a month later, the state Legislature gave the board significant new powers that paved the way for its current building boom. And Mayor Richard M. Daley appointed a school leadership team that went on to win over a once skeptical financial community.

Buy bonds

The legislation, for one, gave the board access to large sums of previously earmarked money—more than $60 million that had gone to teacher pensions, for example, and more than $26 million in state Chapter 1 funds.

With this money and budget cuts—$78 million in central office employees and non-teaching staff, for example—the board was able to take an existing source of revenue that had been paying for general operations and divert it to pay off principal and interest on bonds.

Under the provisions of the board’s bond deal, investors have first dibs on the board’s corporate personal property replacement tax, a $100 million-plus stream of revenue that comes from the state. In fact, the Illinois Department of Revenue is now required to turn over the board’s share of the tax to a trustee, who deducts enough to pay off principal and interest on the bonds and then sends what’s left to the board.

“If you buy a bond, what you’re really doing is making a loan,” explains Steven Eaddy, a public finance director at Fitch Investors Service in New York. “If you’re willing to loan somebody money, it’s with the expectation they’re going to pay you back. The funding source to repay any bond deal is extremely important.”

Debt questions

Current payments on last year’s $350 million bond issue take only $21 million of that money; by 2009, the sum will grow to $30 million. However, this year’s planned sale of another $500 million in bonds will increase the bite.

All this comes at a time when the board is adding and expanding programs—for example, new alternative schools, more preschool classes and university consultants for schools on probation.

Indeed, last school year, the board spent more money than it took in, according to its audited year-end financial statement. That happened in part because it scaled back property taxes and dipped into reserves instead. For this school year, the board raised property taxes by $49 million.

However, the state’s property tax cap limits that avenue of support. Under the cap, the board’s annual property tax take can increase no more than 5 percent or the rate of inflation, whichever is lower. For the upcoming school year, that translates into roughly $30 million, says Chief Executive Officer Paul Vallas.

Some board watchdogs fear an escalating tug-of-war between debt payments and operating expenses. “On one hand, the schools are in terrible shape,” says Diana Lauber, senior program director at the Cross City Campaign for Urban School Reform. “On the other hand, the question is, how does this affect programs?”

“There has not been a whole lot of public discussion about what the options are,” observes Jacqueline Leavy, executive director of the Neighborhood Capital Budget Group. “It seems to us that this is a tremendous amount of debt to take on so suddenly. At what point does it put a strain on the school’s operating budget?”

Warren Matha, a financial consultant to the board, provided insight on such questions at a Feb. 12 meeting of the board’s Blue Ribbon Advisory Committee on Capital Improvements. To finance the capital plan beyond this year’s bond issue, “we could squeeze more debt service out of the operating budget, given certain assumptions,” he said without going into detail.

“This is a dance,” he explained. “We do the choreography as we go along. We’re mice in a maze, going down whichever path looks promising. If the cheese isn’t at the end of one path, we go back and look down another one.”

However, Vallas assures that both debt and educational programs are covered. “Our long-term financial plan balances everything out,” he says. “The current financial plan already assumes debt service for $800 million in bonds.”

School Finance Authority Chairman Martin Koldyke backs Vallas up. “We have a very solid board and a competent CEO. Any organization that has a solid board and CEO doesn’t need an overseer.”

Vallas is looking to cut a number of expenses next year. Those include eliminating more than 700 jobs through layoffs and attrition, changing school bus routes and increasing HMO co-payments for workers who participate in the plan.

Cost-cutting: Class size

However, if disaster somehow strikes, the system has an out, also courtesy of the 1995 legislation: It can put more children into classes and, thereby, lay off teachers to save money. (For every one-student increase in class size, the system would save $11 million.) Previously, maximum class sizes were locked in by the Chicago Teachers Union contract. That changed with the 1995 legislation, which barred union negotiations on class sizes and other working conditions.

There has been no hint that the Reform Board has even considered taking advantage of its flexibility on class size. Before teachers voted on their 1995-1999 contract, the board adopted the previously negotiated class size limits as a matter of board policy.

But the official document that outlines the provisions of last year’s bond issue makes clear that class size is an important part of the equation. “[T]he Reform Board of Trustees adopted a policy which provides that the Board may increase or adjust class size … without obtaining the prior approval or consent of the [Chicago Teachers Union],” the bond statement notes.

Cost-cutting: Teachers’ salaries

The bond statement also highlights another escape hatch: The 1995-1999 contract does not guarantee teachers’ raises beyond the first year. As the bond statement puts it, “In the event that the Reform Board of Trustees determines … that sufficient funds will not be available to pay such scheduled salary increases, such increases will be reduced, deferred or rescinded.”

This flexibility is especially important to the people who rate the credit worthiness of the Chicago Public Schools.

“It gives them greater control,” explains bond analyst Harvey Zachem of Moody’s Investors Service. “It’s an indication they can better manage and control [the district]. We wouldn’t have signed a ‘Baa’ rating if it wasn’t clear there was a major restructuring underway.”

The ‘Baa’ rating indicates that Moody’s considers the board’s bonds to be a relatively secure investment. After buying insurance on the bonds, the board saw its rating leap to triple ‘A.’ In the bond market, the higher the rating, the less interest the seller has to pay.

As for the salary raises, Vallas again assures: “The raises will go as scheduled. There’s no need to [deny them] if the money’s there. There will be no Bill Singer surprises.”

Vallas is referring to William Singer, a prominent Chicago attorney who served on a previous board of education that promised three years of 7-percent raises, and then couldn’t deliver.

As part of a strategy to get more state aid for Chicago’s public schools, Vallas has proposed an extension of the current teachers contract, including annual raises of about 3 percent, unguaranteed. The board can afford those increases under its current tax structure, says Vallas, and any additions from the state would go into expanded services for children—longer school days, more preschool classes and all-day kindergarten, for example.

CPS and the bond market

Although the school system’s financial situation had changed dramatically by the time it went out to peddle bonds, board officials still had a hard sell. Rating agencies, underwriters and investors had lingering memories of the system going bankrupt in 1979, and of more recent fiscal troubles that required the Chicago School Finance Authority to sell bonds to get schools open.

“For a long time, the schools were in sorry financial shape,” comments analyst Eaddy. “From a credit perspective, those weren’t good things.”

But in repeated trips to New York financial offices, the Vallas team was impressive. In Chicago, it took analysts on a tour of one school in dire need of repair and another new, state-of-the-art structure. Even Mayor Daley weighed in with a personal appearance to assure that the city supported the capital efforts.

In the end, Eaddy says, Fitch was impressed enough by Vallas and his management team to rate the school debt at investment grade level. “We give a lot of credit to management,” he says.

The ratings boost was all lead underwriter Bank of America needed to hit the phones and start selling. Potential buyers were invited to participate in conference calls to hear details on the new bonds. By the time the bonds went to market last April, Bank of America received more orders than it could fill—the securities sold out in two hours.

Buy more bonds?

Now, Vallas is looking beyond this spring’s $500 million bond sale for other funding sources to make good on announced rehab and construction plans, which outstrip expected bond money by some $600 million.

Topping his wishlist is legislative approval for the School Finance Authority to sell more construction bonds. This could be done without a property tax increase, Vallas says, by refinancing the authority’s outstanding debt so that smaller payments would be made over a longer period of time; then, the annual “savings” would be used to pay off the new debt.

If approved, the schools could borrow another $300 million to $400 million toward completing planned capital projects, says Vallas.

Federal/state legislative funding

The federal and state governments are more distant possibilities for capital project funds.

Sen. Carol Moseley Braun has President Clinton’s backing for a $5 billion bill to rebuild schools nationwide. If approved, it could mean a $117 million cash infusion for Chicago schools, according to her staff.

In Springfield, a bill has been introduced to issue $1 billion in construction bonds for the state’s most needy districts. One state legislator speculates money for school rehab may be included in a bill encompassing school finance reform.

If distributed on the basis of enrollment, Chicago’s schools could get $220 million.