Correction: Fitch Downgrades Dayton School District, OH to 'BBB+' on Criteria Change; Outlook Stable
Fitch Ratings has downgraded the following Dayton School District, OH underlying ratings based on review of the credit under Fitch's revised criteria for U. S. state and local governments:
--District's Issuer Default Rating (IDR) to 'BBB+' from 'A';
--$171.2 million unlimited tax general obligation (ULTGO) bonds to 'BBB+' from 'A';
--$5.5 million limited tax general obligation (LTGO) bonds to 'BBB+' from 'A';
--$13.7 million certificates of participation (COPs) series 2012 to 'BBB' from 'BBB+'.
The Rating Outlook is Stable.
SECURITY
The ULTGO bonds are voted general obligations of the district payable from an unlimited ad valorem tax levy on all taxable property within the district.
Additional security for the series 2014 and 2013A ULTGO refunding bonds is provided by the Ohio School District Credit Enhancement Program (rated 'AA'; Outlook Stable).
The LTGO bonds are non-voted general obligations of the district payable from an ad valorem tax levy within the 10-mill limitation.
The COPs are payable from the district's obligation to make rental payments under the lease subject to annual appropriation. The COPs carry a leasehold interest for the benefit of certificate holders in the leased assets.
KEY RATING DRIVERS
The downgrade reflects implementation of Fitch's revised criteria for U. S. state and local governments, released on April 18, 2016. Underlying credit factors since the time of Fitch's last review of the district are mostly stable to positive; however, the revised criteria place increased focus on Fitch's expectations for the natural pace of revenue growth without revenue-raising measures, the ability of an entity to independently increase revenue, and the ability of an entity to manage a budget gap that may occur in an economic downturn. The downgrade reflects Fitch's concern that the district's limited revenue and expenditure flexibility would hamper its ability to maintain positive reserve levels in an economic downturn.
The now one-notch distinction between the 'BBB+' IDR and the 'BBB' appropriation-backed bond rating also reflects Fitch's application of its revised criteria. The revised criteria include more focused consideration of project factors in ratings for appropriation-backed debt. The COPs do not carry any of the additional risk features that Fitch identifies for rating more than one notch below the IDR.
Economic Resource Base
The district serves approximately 13,000 students and has experienced significant declines in enrollment as a result of population outflow and competition from charter schools. The city of Dayton's population of approximately 140,599 (estimated 2015) has declined by more than 15% since 2000 but has remained fairly stable since 2010.
Revenue Framework: 'bbb' factor assessment
Fitch expects revenue growth to be slow going forward. The district's independent legal ability to raise revenue is restricted by state legal parameters.
Expenditure Framework: 'a' factor assessment
Fitch expects that the natural pace of spending growth will be above that of expected revenue growth. We believe that the district's ability to cut spending is constrained, with the risk of reduced delivery of core services in a downturn in the absence of offsetting policy action.
Long-Term Liability Burden: 'aa' factor assessment
Long-term liabilities, including the pension liability and overall debt burden, are moderate relative to the resource base.
Operating Performance: 'bb' factor assessment
Fitch expects the district will be challenged to maintain positive reserve levels in an economic downturn. The district has not been able to build reserves through FY 2015 and may be required to defer required spending in future economic downturns given current relatively low reserve levels.
RATING SENSITIVITIES
Increase in Reserves: The rating is sensitive to the ability of the district to maintain available reserve levels that Fitch would view as adequate at the current rating through an economic cycle.
State Aid Changes: The district's rating is sensitive to changes in state aid funding and policies, including changes in the state aid formula, as state aid represents the bulk of the district's revenues.
Increased Competition: The rating is also sensitive to charter school and open-enrollment competition increasing, which would heighten expenditure pressure and reduce financial flexibility.
CREDIT PROFILE
The district encompasses 49 square miles in Montgomery County, 68 miles west of Columbus, including Harrison and Jefferson townships and portions of the cities of Dayton, Riverside and Trotwood. The city's unemployment rate remains elevated compared to state and national rates, but is improving. Income levels as measured by per capita money income and median household income are well below state and U. S. averages. Typical of urban areas, the poverty level is more than double that of the state and nation.
The area's traditional manufacturing base in automobile parts and assembly was devastated by the recession, but is showing signs of recovery. The region has established itself as a hub for aerospace research and development; and Wright-Patterson Air Force base, which employs approximately 27,000 civilian and military personnel, provides some stability to the local economy. The weakness in the local economy in the last decade has contributed to significant enrollment declines.
Revenue Framework
Ohio school districts operate within a restrictive revenue environment. Partially due to its low wealth levels, the majority of Dayton City school district's general fund revenue comes from state aid (73% of fiscal 2015 revenues) as opposed to property tax revenue (26%). The district has benefited from state aid increases under the state funding formula, since it incorporates relative wealth and income, factors that have offset enrollment declines in the district. State aid growth is currently capped at 7.5% increases year-over-year.
The district's outside mill levies, which account for almost all property tax revenues, are fixed rate. These levies capture growth due to new construction; however, when assessed value grows due to property appreciation, the rate is rolled back, while the levy declines if assessed value declines; this limits growth potential without reducing downside risk. Positively, all of the district's property tax levies are continuous and do not require a renewal vote.
Fitch expects revenue growth to approximate inflation going forward. Enrollment declines had appeared to be leveling off, with a decrease of 1.2% in the 2014-2015 school year compared to a 1-year CAGR decline of 2.4%, but a large decline in the 2015-2016 school year of 3.9%, to approximately 13,000, suggests that declines could be accelerating again. The district expects to remain at the 7.5% cap on state aid increases through the state's current biennium budget and at the subsequent cap going forward, which provides some cushion against the potential revenue impact of ongoing enrollment declines. Continued weak relative wealth and income levels also should limit the risk of the district's state aid decreasing.
The district has no ability to independently increase its main revenue sources. State aid increases are derived from a state aid funding formula and any new property taxes must be approved by voters.
Expenditure Framework
The district's main expenditure items are teacher instruction (58% of FY 2015 general fund expenditures) and support services (27%). The remaining FY 2015 spending was on debt service and a swap termination fee.
Fitch expects the natural growth of expenditures will be above the slow natural growth rate of revenue. The district projects a FY 2015 to FY 2020 six-year expenditure CAGR of about 4%, which Fitch believes is reasonable considering the district is assuming 5% average annual increases in personnel costs due to cost of living wage increases.
The district maintains relatively limited control over its expenditures despite moderate carrying costs for debt service and OPEB and pension contributions (about 11% of governmental fund expenditures), due to the large portion of the student population enrolling in alternative school options. The district projects increasing competition from open enrollment, charter schools, and other school options which may increase expenditure pressure. The district projects that the number of students using alternative schools will increase from 9,710 (43.5% of 2016 district enrollment) to 12,002 (51.8%) in FY 2020. Under this scenario, which may be conservative, the proportion of the district's budget comprised of state aid funding pass-through to competing school options would remain high. State aid funding received by the district and sent to those alternate school options is projected to remain above 30% through FY 2020. Positively, declining enrollment does enable the district to replace staff at a slower rate.
The district maintains moderate control over its workforce-related spending. The district's collective bargaining agreement with its teachers (50% of the unionized workforce) expires on June 30, 2017. A joint teacher/administration compensation committee is investigating making changes to teacher compensation, such as single salary steps, career ladder options, and performance options, which may give the district greater control over workforce expenditures. The contract does contain wage reopeners.
Long-Term Liability Burden
The district's moderate long-term liability burden is a credit strength for the district. The combined net pension liability, adjusted for a 7% investment return assumption, and overall debt burden is 12.9% of personal income, with each component representing about half of the overall burden. The district has no plans to issue debt in the intermediate future. The district participates in two multiple-employer defined benefit pension plans - the Ohio School Employees Retirement System and the Ohio State Teachers Retirement System. Fitch calculates the district's share of the net pension liability to equate to a 68.3% ratio of assets to liabilities, assuming a 7% discount rate.
Operating Performance
The district had negative available general fund reserve levels in 2014 (negative 1.7% of general fund expenditures) which increased to positive 1.8% in 2015. The district is projecting a significant surplus of over $17 million on a cash basis in FY 2016. Failure to achieve a similar surplus on a GAAP basis in the FY 2016 audit may place negative pressure on the rating. Despite the projected surplus, Fitch expects the district will be challenged to maintain reserve levels throughout an economic cycle given its level of budget control, absent voters approving a new tax levy. Voters did approve the last operating levy the district proposed in 2008, but rejected a five-year emergency levy proposed in 2007.
Through FY 2015, the district has been unable to rebuild reserves to a level that would offset its limited revenue and expenditure controls. Given these limitations, in a moderate economic downturn scenario the district may be forced to make difficult decisions to either defer required spending or to reduce spending on core educational programming. This poses an additional challenge if reduced educational spending contributes to continued decreasing enrollment in the district as students increasingly choose to go to charter schools and other competing school districts for better-funded educational programs. Positively, the district did maintain an additional unrestricted $18.4 million in its internal service funds in FY 2015, $14.2 million of which was in its self-insurance fund.
The district is projecting increases in available fund balance through FY 2020 due to continued increases in state aid (7.5% state aid growth assumed in FY 2016 and FY 2017 and 6.5% in FY 2018 through FY 2020). Fitch notes that the state has not yet determined what the cap will be on year-over-year state aid increases in FY 2018 through FY 2020. While the district projects state aid increasing by $36 million (23%) from FY 2016 through FY 2019, Fitch also notes that, based on the district's official projections, some of the increase will be offset by increases in spending being passed through to open enrollment, charter schools, and other educational options (an increase of 22%/$15 million assumed over the same period).
In accordance with Fitch's policies the issuer appealed and provided additional information to Fitch that resulted in a rating action that is different than the original rating committee outcome.
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