Fitch Rates Grossmont Union High School District (CA)'s ULTGO 2016B Bonds 'AAA'; Outlook Stable
--Approximately $80.6 million general obligation (GO) refunding bonds series 2016B.
The bonds will be sold via negotiation during the week of September 22. Proceeds will refund outstanding debt for interest savings and pay cost of issuance.
In addition, Fitch has affirmed the following ratings:
--$47.5 million outstanding GO refunding bonds, series 2016 at 'AAA'.
-- Issuer Default Rating (IDR) at 'A'.
The distinction between the 'AAA' rating on the bonds and the 'A' issuer rating reflects Fitch's assessment that bondholders are legally insulated from any operating risk of the district.
The Rating Outlook is Stable.
The GO bonds are secured by unlimited ad valorem property taxes levied on all taxable property in the district.
KEY RATING DRIVERS
SPECIAL REVENUE ANALYSIS: The 'AAA' unlimited tax general obligation bond rating is based on a dedicated tax analysis without regard to the district's financial operations. Fitch has been provided with legal opinions by district counsel that provide a reasonable basis for concluding that the tax revenues levied to repay the bonds would be considered 'pledged special revenues' in the event of a district bankruptcy.
STRONG TAX BASE; LOW DEBT: The economic resource base supporting the GOs is diverse, growing at a healthy pace and reasonably stable in downturns. The unlimited nature of the tax offsets any concern about tax base volatility. Overall debt is low relative to the economic resource base.
TAX BASE DRIVES GO RATING: Grossmont Union High School District's 'AAA' general obligation bond rating could come under downward pressure in a significant and long-lasting decline in the district's tax base and economy, which Fitch believes is unlikely.
IDR SENSITIVE TO FINANCIAL PERFORMANCE: The 'A' IDR could come under downward pressure if the district fails to maintain structural budget balance and reserves above the minimum levels required by the state of California. The rating could come under upward pressure if the district builds and maintains more robust reserves relative to historical revenue volatility.
Grossmont Union High School District serves a 456 square mile area in San Diego County (IDR 'AAA'/Stable Outlook). The district is home to 477,712 residents and has an enrollment of 17,243. Its boundaries include the entire cities of El Cajon, Santee and Lemon Grove, most of La Mesa, a small portion of the city of San Diego and a number of unincorporated areas within the county. It operates nine comprehensive high schools, two charter schools and a continuation high school, as well as adult education, career technical, alternative and special education programs.
DEBT SERVICE LEVY VIEWED AS 'SPECIAL REVENUE'
Fitch believes that taxes levied for bond repayment would be considered pledged special revenues under the U. S. bankruptcy code and therefore the lien on pledged revenues would survive and would not be subject to the automatic stay (i. e., payment interruption) in the event the district were to file for bankruptcy.
Fitch has reviewed and analyzed legal opinions provided by district counsel and believes they provide a reasonable basis to conclude that these revenues would be treated as pledged special revenues due to certain provisions of the state constitution (primarily proposition 13), which limit and direct the use of pledged property tax revenues for bond repayment.
As a result, Fitch analyzes these bonds as dedicated tax bonds. This analysis focuses on the district's economy, tax base and debt burden without regard to financial operations because Fitch believes that bondholders are insulated from any operating risk of the district. Fitch typically calculates the ratio of available revenues to debt service for dedicated tax bonds, but the unlimited nature of the tax rate pledge on the district's bonds eliminates the need for such calculations.
STRONG TAX BASE SUPPORTS BONDS
The district's large and diverse tax base and economy provide a strong basis for repayment of the ULTGO bonds that is unlikely to be reduced by normal or even moderately severe cyclical fluctuations.
The tax base is growing at a healthy pace after experiencing moderate declines (6.6% over two years) during the Great Recession. Assessed value (AV) has risen an average of 4.9% annually over the past two decades and rose 5.4% to $42 billion in fiscal 2016. Prospects for further growth in the district appear solid. The district includes substantial developable land and is within commuting distance of major San Diego employment centers. Growth has traditionally been driven by middle class workers seeking affordable homeownership away from the very expensive housing markets of the region's coastal cities. There is no taxpayer concentration with the top 10 taxpayers accounting for just 2.7% of secured AV and no single payer accounting for more than 1%. The overall tax base is largely residential (86% of AV).
Tax rates are low and unlikely to rise to a level that pressured the rating even under relatively severe stress scenarios. The general tax rate of 1% of AV is set by Proposition 13 and may not be increased. The debt service tax levy (which varies automatically with debt service and AV changes) is low at just 0.21% of AV for 2016 for all taxing jurisdictions and 0.06% for the district's debt. Fitch believes the tax base is very unlikely to suffer losses that would meaningfully erode repayment capacity.
IDR EXPANDS ANALYSIS TO INCLUDE OPERATING PERFORMANCE AND FRAMEWORK
The 'A' IDR reflects a strong financial oversight framework, adequate expenditure control and low debt burden. The rating is below average for the sector due to the district's weak revenue framework and limited financial flexibility.
Economic Resource Base
The district's economy is solid, benefitting from its location in the large and diverse San Diego County employment market. The county's job market generally tracks the national economy well and is experiencing a strong cyclical upturn. The county's non-seasonally adjusted unemployment rate was low at 5.3% in July 2016. Income indicators are healthy despite considerable variation across the district. Overall district median household income is solid at 115% of the national median and 102% of the state median, but just 93% of the of the county level. The individual poverty rate is below the national average 13.2%.
Revenue Framework: 'bbb' factor assessment
The district is largely reliant on formulaic per pupil funding from the state of California, and policymakers have no meaningful independent revenue raising flexibility due to tax limitations. Revenue performance has been weak despite recent gains in per pupil funding due to the district's declining enrollment.
Expenditure Framework: 'aa' factor assessment
The expenditure framework is healthy with expenditures generally tracking revenues. Expenditure flexibility is solid with moderate fixed costs for debt and retiree benefits. Management retains the ability to control labor costs and staffing levels after engaging in a structured bargaining framework.
Long-Term Liability Burden: 'aaa' factor assessment
Debt and pension liabilities are low relative to the large economic resource base.
Operating Performance: 'bbb' factor assessment
Financial resilience through downturns is below average for the sector due to legal constraints on revenue raising and low reserves relative to historical revenue volatility. Budget management can remain challenging well into times of economic recovery. Draws on fund balance persisted through fiscal 2015. However, the district appears to have returned to surplus operations in 2016.
The weak revenue framework is the primary driver of the below-average IDR. The district is dependent on the State of California Local Control Funding Formula (LCFF) for about 80% of its revenues. State funding provides a broad and strong economic base for district revenues, constitutional priority for education funding and minimum funding levels, but it is also somewhat more volatile than typical municipal revenues. Demographic declines in enrollment and competition from charter schools exacerbate the volatility of state funding to the district.
Fitch expects revenues to remain stagnant until the district's enrollment stabilizes. Future revenue growth will be determined by overall state revenue performance, LCFF funding levels and attendance. The 10-year compound annual growth rate of general fund revenues was well below economic growth and the rate of inflation at 0.6% in 2014 and 0.3% in 2015. This pattern is not unusual for mature California suburbs past their rapid growth phase in communities with fewer young families, but it is exacerbated in the district by competition from charter schools. District enrollment has declined by more than 10% since 2011.
The district has no meaningful independent revenue raising ability due to strict property tax limitations of California's Proposition 13. The district may only raise taxes with a vote of the electorate, and it may not raise its operating property tax levy under any circumstances.
Labor costs for teachers and staff comprise the vast majority of district expenditures, and spending control is the district's main method of financial management.
Spending growth is likely to keep pace with stagnant revenues because the district's declining enrollment allows gradual declines in staffing to match revenue weakness. Spending tends to outpace revenues during downturns and the early stages of recovery but tracks revenues well on average across the business cycle.
Expenditure control is solid. The district's fixed costs for debt service and retiree benefits are moderate at 18% of governmental funds expenditures. The district operates under the standard California school district labor relations framework, which requires management to meet and confer with organized labor but ultimately allows management to impose terms on workers in the rare instances where an agreement cannot be reached. The district also has some ability to increase class sizes to reduce staffing needs during downturns.
Long-Term Liability Burden
The district's direct debt portfolio is dominated by GO bonds with some historical use of capital appreciation bonds. The long-term liability burden (direct and overlapping debt plus the Fitch-adjusted net pension liability) is low at just 8.9% of personal income. The district has $128 million of approved but unissued GO bond authorization available and plans to issue new debt gradually as AV rises to keep tax rates at levels presented to voters when the bonds were approved. The district is considering asking voters for the authority to accelerate issuance, but the debt burden would remain moderate even if the full authorization were issued immediately. Direct debt amortization is slow with just 31% of debt paid off in the next decade.
The district's $188.8 million unfunded pension liability (adjusted for Fitch's standard 7% rate of return assumption) makes up about a quarter of the district's direct long-term liabilities. The district participates in state-run pension systems that are adequately funded, and reforms adopted in 2012 should slow the growth in pension liabilities over time. Actuarial assumptions for the district's pensions are standard.
Financial resilience through downturns is limited due to the low level of district reserves relative to revenue volatility. Fitch's standard 1% decline in U. S. GDP stress scenario suggests the district may experience a general fund revenue decline of 7.8% in a moderate economic downturn, according to the Fitch Analytical Sensitivity Tool (FAST). At 5.5% of spending at the end of fiscal 2015, unrestricted general fund balance would be insufficient to absorb this hypothetical revenue stress. Unaudited actual results for fiscal 2016 and the district's 2017 budget suggest the reserve safety margin will exceed the FAST stress scenario by the end of 2017. However, the district manages its budgets to comply with a board reserve policy of just 4.5%, suggesting the district may have future periods in which fund balances are quite low relative to historical revenue volatility. With limited reserves, Fitch expects the district to manage revenue declines primarily through expenditure controls. Inherent budget flexibility is considered midrange - or typical for the sector - because the district has solid control over its spending. Fitch believes the district's financial operations could become stressed in a downturn, but are likely to recover as economic conditions improve.
Budget management in times of recovery is mixed. The district budgets conservatively and undertakes frequent multiyear forecasting with oversight from the county office of education under California's robust Assembly Bill 1200 school financial oversight framework. However, weak revenue performance has prevented the district from rebuilding significant financial flexibility until much later in the current economic expansion than the typical school district. The district recorded net deficits in its general fund for each of the past four fiscal years, lowering unrestricted fund balance to $10.5 million, or a modest 5.5% of general fund spending at the end of fiscal 2015. The district's multi-year projections show a return to positive operating results from 2016 to 2018.