Increased financial pledges from city and state sources triggered a two-notch upgrade for the long-struggling Philadelphia School district to a higher speculative-grade rating ahead of a more than $600 million bond deal that will also benefit from state credit support.

Fitch Ratings upgraded the system’s issuer default rating to BB-plus from BB-minus Thursday, citing positive fiscal improvements achieved after recent funding increases from Philadelphia and Pennsylvania. The higher Fitch mark puts the cash-strapped district one notch below investment grade just before it is scheduled to sell $663 million of bonds in a negotiated transaction the week of Oct. 16.



Moody’s Investors Service upgraded Pennsylvania's largest district to investment-grade Baa3 from speculative-grade Ba2 in December after a new mayor-appointed school board took effect in July 2018 after more than 16 years of state control. That upgrade gave Philadelphia School District bonds an underlying investment grade rating from Moody’s for the first time since 1977.

"We are very pleased that Fitch recognized our continued fiscal progress with a two level upgrade to our bond rating,” Uri Monson, chief financial officer for the school district, said in a statement. “This second upgrade of two notches by a major rating agency in less than nine months is a clear signal to the public and the marketplace that the School District has a fiscally responsible approach to managing its $3.5 billion budget."

Fitch analyst Eric Kim noted that a $600 million increase in city funding from Philadelphia to be phased in over multiple years materially increases the school district’s ability to match recurring revenues and recurring expenses. Kim said the “significant funding commitment”, which was achieved primarily through increased direct grants or appropriations, shows that the city and district are more closely linked financially following several rounds of increased state support in recent years.

“The revenue has materially improved the trajectory of the district's operating performance and supports progress toward structural balance," Kim wrote. “Following the multi-year phase-in of a sizable increase in local aid beginning in fiscal 2019, Fitch anticipates local revenues will increase at a pace similar to commonwealth aid to the district.”

Kim noted that Pennsylvania over the past several years stabilized and made permanent a dedication of cigarette tax revenues of numbering a least $58 million annually to the Philadelphia schools. The state has also provided the district three straight years of basic education funding increases under a more favorable funding formula.

The upcoming bond sale includes $300 million of series A general obligation bonds that will fund various capital projects. Series B and C GO bonds totaling $49.41 million will be used to finance certain infrastructure initiatives aimed at reducing energy usage in district school buildings. An additional $125.865 million of forward delivery series C GO refunding bonds and $187.77 million of State Public School Building Authority lease revenue bonds are also planned as part of the transaction.

All of bonds are enhanced by legal protections for bondholders under the Pennsylvania School Credit Intercept Provision. The bonds were assigned A-plus ratings by Fitch under the Keystone State’s credit enhancement program. The district and SBSBA have a combined $2.8 billion in debt outstanding, according to Fitch.

Moody’s rated the Philadelphia School district deal at an underlying Baa3 with a stable outlook. The bonds were also assigned an A2 enhanced rating under the intercept program.

Mayor Jim Kenney pledged $1 billion in total funding to the Philadelphia schools last year to help it plug a $900 million deficit projected in 2023. Kim noted that a roughly $40 million net operating surplus equating to an available operating fund balance of $214 million, or 7% of expenditures, is projected for the fourth quarter of 2019. If final results match this forecast, the district will have its highest level of reserves since the 2008 Great Recession, according to Kim.