Overview

Illinois school districts demonstrated credit stability in 2023, and we expect this will continue, supported by a stable state funding environment and generally healthy reserves.

Headwinds include rising labor costs and dwindling federal Elementary and Secondary School Emergency Relief (ESSER) funds, particularly for the minority of districts that used ESSER funds for recurring operating costs. Higher mortgage rates, a slowing national economy, and Illinois' declining population could dampen local tax base growth, though in most cases we do not expect this will materially limit school districts' revenue-raising flexibility. In our view, most districts are well positioned to navigate these challenges in the near term given the state's commitment to funding the Evidence-Based Funding (EBF) formula. In addition, the cumulative effect of ESSER, EBF, and elevated corporate personal property replacement tax (CPPRT) distributions has allowed many districts to shore up reserves and address capital needs.

S&P Global Ratings maintains ratings on general obligation (GO) or GO-equivalent debt for 424 school districts in Illinois. Ninety-eight percent of the ratings have a stable outlook, with three on positive outlook and seven on negative. Overall, credit quality has been stable over the past year, with 17 school district debt ratings raised since April 26, 2023. Over the same period, we lowered four school district debt ratings, and revised the rating outlook to positive from stable on two school districts and to negative from stable on one.

What We Are Watching

In 2023 and early 2024, Illinois school districts' credit quality remained stable, and we expect this will continue through at least the near term given districts' generally healthy reserves and the favorable state funding environment. Since EBF was enacted in 2017, the state has met the statute's $350 million targeted annual funding increase in six of seven fiscal years, holding funding steady in fiscal 2021 due to revenue loss associated with the pandemic. The governor's fiscal 2025 budget proposal includes another $350 million increase. The formula's hold-harmless provision is a key source of credit stability for districts that rely on state aid because it means enrollment declines, which can pressure finances for districts in states with per-pupil education funding, do not lead to a loss of state aid in Illinois.

While we expect CPPRT revenue will diminish in the near term, in most cases this will be manageable unless this volatile revenue source is relied on for budgetary balance. CPPRT is a statewide tax on corporations' and other entities' earnings that is distributed to local governments, including school districts. The recent jump in distributions appears driven by strong corporate earnings and statutory changes. According to the Illinois State Board of Education (ISBE), CPPRT distributions moderated in calendar year 2023, and we expect this softening will continue as the national economy transitions to slightly below-potential growth in the next couple of years (see "Economic Outlook U.S. Q2 2024: Heading For An Encore," published March 26, 2024).

Historically high inflation has also provided districts subject to PTELL additional revenue-raising flexibility, helping to offset some of the pressure related to rising operating and capital costs. PTELL limits annual property tax levy growth to the lesser of 5% or the annual Consumer Price Index increase for the year preceding the levy year, excluding new construction. For the first time since the law's passage in 1991, districts were able to increase their levy by the maximum of 5% for taxes payable in calendar year 2023 and 2024, and they will be able to increase their levy by up to 3.4% in 2025, larger than any year since 2009, excluding 2023 and 2024.

As with many school districts across the country, finding qualified teachers and support staff is a challenge in a tight labor market. Districts that have agreed to contracts with elevated annual pay increases may struggle to maintain balanced results, and while inflation has moderated, the cumulative erosion of purchasing power in the last few years will likely continue to lead to higher salary demands in the near term.

ESSER funds must be obligated by Sept. 30, 2024, and according to the ISBE, just under 20% of the total statewide allocation remains. Most districts have primarily used ESSER funds for one-time purposes, such as addressing capital needs or hiring temporary staff. However, districts that have used the funds for existing or additional recurring operating expenses may struggle to maintain balanced operating results once ESSER funds are depleted.

Spotlight On Environmental, Social, Governance Factors

Statewide, we view credit factors related to energy transition or physical risks as neutral in our analysis. While the state has experienced localized physical risks arising from extreme weather, including periodic flooding and tornadoes, and from ongoing erosion of the Lake Michigan shoreline, we do not expect these conditions will be immediate risks to the credit quality of its school districts.

Furthermore, we typically view social capital factors as neutral in our credit rating analysis. We note that the state is experiencing ongoing population decline, mainly downstate but also recently in the Chicago metropolitan statistical area, as residents move to warmer parts of the country and to states with a lower tax burden. However, in most cases we do not expect population loss will pressure districts' finances. As stated, enrollment declines do not reduce state aid for school districts given EBF's hold-harmless provision. Furthermore, districts subject to PTELL are allowed an annual inflationary increase in their levy, even if the tax base is stagnant or declining due to demographic trends. Over the long term, sustained population decline could limit certain district's access to labor, willingness to raise their levy on a smaller pool of residents, and for tax-capped districts, capacity to raise their levy, making it difficult for such districts to sustain current levels of educational services.

Illinois school districts are exposed to risks associated with significantly underfunded pension liabilities from the state's primary teacher's pension plan, TRS. While the state makes most annual pension payments on behalf of Illinois school districts to TRS, school districts are potentially exposed to future budgetary risks should the state shift a greater percentage of the annual cost of TRS onto districts. We note there have been no state-level discussions regarding shifting costs to school districts for several years, and we think the state's currently positive budget trajectory means the state is less likely to shift costs at least in the near term. We view poor pension plan governance, including those present with TRS, as an overlap with risk management, culture, and oversight when the potential for changes at the plan or state level could lead to additional costs or significant budgetary disruption to Illinois school districts. In addition, some Illinois school districts demonstrate weaker risk management, culture, and oversight because of vulnerable management practices under our Financial Management Assessment methodology, weak internal controls, and management turnover.

Illinois School District Data

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