OREANDA-NEWS. Fitch Ratings has downgraded the following Berea City School District, OH rating to 'A-' from 'A+'s:

--Issuer Default Rating (IDR);

--$3.9 million unlimited tax general obligation (ULTGO) bonds;

--$2.7 million limited tax general obligation (LTGO) bonds;

--$1 million special obligation tax anticipation notes (TANs).

The Rating Outlook is revised to Stable from Negative.

SECURITY

The ULTGO bonds are backed by an ad valorem tax levied on all taxable property within the district, without limitation as to rate or amount.

The LTGO bonds are non-voted general obligation debt of the district secured by an ad valorem tax levy within the 10-mill limitation.

The special obligation TANs are secured by proceeds from a 1-mill permanent improvement levy.

The Rating Outlook is Stable.

KEY RATING DRIVERS

The downgrade to 'A-' from 'A+' reflects implementation of Fitch's revised criteria for U. S. state and local governments, which was released on April 18, 2016. The revised criteria place increased focus on the pace of natural revenue growth and the ability of an entity to independently increase revenue as well as the ability of an entity to manage a budget gap that may occur in an economic downturn. Fitch expects that the district's natural revenue growth will be stagnant and that it has very limited flexibility to increase local revenue sources independent of voter approval. Fitch also believes that a recessionary period would have significant negative effects on operations and reserve levels.

Economic Resource Base

The district is mostly residential with a fairly stable and mature economy 18 miles west of Cleveland.

Revenue Framework: 'bbb' factor assessment

Fitch Ratings expects the district to continue to experience stagnant revenue growth below the pace of inflation and GDP. The district also has very limited ability to increase revenues as it relies primarily on a fixed rate property tax levy for which increases must be approved by voters.

Expenditure Framework: 'aa' factor assessment

Expenditure growth has outpaced revenue growth, which has led to several deficits over the last several years. This reflects the very limited revenue growth potential in the absence of voted increases. Positively, the district has solid flexibility to control expenditure items, with fixed carrying costs for debt service and retiree benefits well below 20% of expenditures.

Long-Term Liability Burden: 'aa' factor assessment

The district has a low to moderate long-term liability burden with unfunded pension liabilities and overall debt currently slightly less than 10% of personal income. This ratio is expected to increase moderately if the district succeeds in its referendum for a new bond levy to support issuance to fund school consolidation plans.

Operating Performance: 'bbb' factor assessment

The district has only adequate gap closing capacity, highlighted by its lack of control over revenues and reserve levels that had dropped to very low levels before recent replenishment to still moderate levels. Based on its current financial position, Fitch believes the district may experience distressed financial operations in a recessionary economic period and will have limited gap-closing capacity.

RATING SENSITIVITIES

Revenue Growth Prospects: The rating is sensitive to any decreases in expectations for state aid or declines in prospects of the property tax base that would further pressure revenue growth beyond already weak levels and further increase pressure on the district's ability to maintain available reserves.

Reserve Expectations: The rating is also sensitive to any material change in Fitch's expectations for available reserve levels that would affect the district's ability to maintain flexibility in an economic cycle.

CREDIT PROFILE

The district serves a mostly mature, suburban community with an estimated 2015 population of 18,874 (down from a peak of 22,396 in 1970, but more stable in the current decade). Enrollment continues to decline despite the stability of the local economy and tax base (6,092 projected in the 2016-2017 school year, down from 7,000 in the 2009-2010 year). The property tax base is diverse with the top 10 taxpayers comprising approximately 10% of assessed value (AV). AV has contracted over the last few years with 2015 AV totaling $1.3 billion, flat with the prior year (better than the projected 7% decline) and a 15% decline since 2008. Unemployment rates have tracked in line with state and national trends.

Revenue Framework

The district is largely reliant on property taxes (61% of FY 2015 general fund revenue) and state aid (33%).Ohio school districts operate within a restrictive revenue environment. The district is limited in its ability to legally raise revenues and a stagnant tax base limits growth prospects. Moreover, most school property taxes in Ohio are not able to capture natural appreciation in assessed values. Fitch expects that the weak revenue framework will significantly limit the district's ability to maintain balanced financial operations.

The district's inside property tax levy, which can capture assessed value increases, accounts for only 3% of 2015 general fund revenue. All of the district's other property tax revenues come from continuous outside millage, which does not need to be renewed by voters (58% of FY 2015 general fund revenue). These levies do capture growth due to new construction, but when assessed value grows due to property appreciation the rate is rolled back. On the other hand, the levy does decline if assessed value declines. Like all Ohio school districts, the district is dependent upon voter approval for new operating taxes.

Prospects for natural revenue growth are weak. Fitch believes that future revenue growth is likely to be in line with historical revenue growth, lagging both CPI and GDP. The district projects property taxes to remain almost unchanged in its five-year projections, which Fitch views as being reasonable as assessed value declines appear to have ended and values are expected to remain stagnant over that period.

The district's state aid growth will also be limited as it will gradually lose revenue from the tangible personal property reimbursement phase-out and the current 7.5% cap on year-over-year state aid increases limits revenue growth. That cap reportedly leaves the district with only 56% of the amount the funding formula would otherwise have granted it. Positively, the district's enrollment declines should not have a significant impact on state aid funding as the district is already well above the state aid cap.

The district is extremely limited in its ability to legally raise revenue due to its reliance on limited property levies and state aid. The property tax levy is limited due to the state framework requiring voter approval for any new levies and the district's other locally controlled revenue sources are minimal.

Expenditure Framework

The district provides K-12 services to the city of Berea, Middleburg Heights, and Brook Park. Main expenditure items are primarily student instruction (60% of FY 2015 general fund expenditures) and support services (36%). Only 3% of general fund and debt service fund expenditures in 2015 were for debt service.

The natural pace of expenditure growth is likely to be above that of revenue growth, largely due to the slow revenue growth as described above. Absent policy action to control costs, expenditures are expected to increase at a rate close to inflation given that expenditures are largely tied to teacher salaries.

The district has solid flexibility with its main expenditure items. Fixed carrying costs for debt service and retiree benefits are moderate at about 11% of expenditures.

The district's workforce flexibility has enabled it to adjust operating costs to match recent enrollment declines (-1.3% CAGR over the last 12 years and -2% projected over the next five years). The district underwent two school building consolidation projects in FY 2012 and FY 2014 reducing annual operating expenditures by about 1.3%. The district expects to undergo another school consolidation project in FY 2019 and expects to save $1.4 million in FY 2019 and $2.8 million annually beginning in FY 2020 (3.7% of FY 2015 expenditures). The district plans to ask voters to pass a 4.2-mill levy to support a bond issue to support the consolidation in November 2016. Declining enrollment also enables the district to replace staff at a slower rate.

Long-Term Liability Burden

The district's long-term liability burden is low to moderate, with the unfunded pension liability and overall debt currently a low 9.4% of district personal income (a combined $227 million). The district has moderate near-term debt plans with a $112 million bond issuance planned to support the FY 2019 school consolidation plan, which would increase the liability burden above 10%. The district participates in two cost-sharing multiple employer pension plans, the Ohio State Teachers Retirement System and the Ohio School Employees Retirement System and contributes 100% of the actuarially-based required contribution to both plans. Fitch calculates the combined adjusted ratio of assets to liabilities to be 68.5% assuming a 7% discount rate.

Operating Performance

The district's revenue limitations and resulting operating deficits through FY 2013 led to weakened reserve levels as expenditure growth outpaced the district's revenue growth. While reserves increased in FY 2014 and FY 2015 due to a new levy, increased state aid, and expenditure reductions through school consolidation, they remain limited. In an economic downturn, Fitch believes the district's limited revenue raising flexibility would lead to stressed financial operations, leaving further expenditure reductions and use of fund balance as the only methods within the district's control to close the subsequent operating gap, absent voter approval of a new tax levy.

The district has taken proactive steps in managing its budget throughout the recovery to maintain positive albeit diminished reserve levels through expenditure cuts and asking voters to approve a new levy in 2012. Expenditure reductions include the aforementioned school building consolidation efforts in FY 2012 and FY 2014 as well as the expected consolidation in FY 2019. Officials anticipate rising costs may require them to ask voters to approve a new levy in FY 2022.