Fitch Rates Los Angeles USD, CA's $1.2B Unlimited Tax GO Bonds 'AAA'; Outlook Stable
--\\$650 million general obligation (GO) bonds, election of 2008, series A (2016) (dedicated unlimited ad valorem property tax bonds);
--\\$575 million 2016 GO refunding bonds, series A (dedicated unlimited ad valorem property tax bonds).
The bonds are expected to sell via negotiation on or about March 1, 2016. New money bond proceeds will fund existing educational facility renovations. Refunding bond proceeds will refund for interest savings certain outstanding GO bond maturities totaling \\$661.2 million.
Fitch also has assigned an Issuer Default Rating (IDR) of 'A+' to the district. 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 bonds are secured by unlimited ad valorem property taxes levied on all taxable property within the district.
KEY RATING DRIVERS - 'AAA' BOND RATING
PLEDGED SPECIAL REVENUES: The 'AAA' bond rating is based on a dedicated tax analysis without regard to the district's financial operations. The district provided Fitch with legal opinions prepared by outside counsel that provide a reasonable basis for concluding that the property tax revenues levied to repay the bonds would be considered 'pledged special revenues' in the event of a district bankruptcy.
STRONG DEDICATED REVENUE STREAM: Fitch expects the property tax revenues dedicated to GO bond repayment to continue benefitting from positive tax base growth associated with the district's huge, diverse, and growing economy.
MODERATE LONG-TERM LIABILITY BURDEN: The district's debt burden is moderate with average amortization.
KEY RATING DRIVERS - 'A+' ISSUER DEFAULT RATING
IDR REFLECTS CHALLENGED FINANCES: In addition to the factors noted above, the 'A+' IDR considers the district's financial operations. The district is currently benefitting from improved state education funding, particularly given its high population of targeted students. However, sustained declining student enrollment contributes to fiscal challenges as enrollment drives a large portion of revenues. The IDR also incorporates both the district's rising fixed costs (including retiree costs) and its demonstrated ability to contain spending as needed.
SOLID TAX BASE AND ECONOMY: The 'AAA' GO bond rating is sensitive to material negative changes in the district's tax base and economy, which Fitch considers are unlikely.
IDR SENSITIVE TO FINANCIAL PERFORMANCE: The 'A+' IDR is sensitive to the district's ability to close the structural budget gaps in fiscals 2017 and 2018 and maintain satisfactory reserves through expenditure cuts if revenues do not rise sufficiently.
The district is the nation's second largest public school district and operates 1,035 schools and educational centers plus 53 affiliated charter schools. A further 211 fiscally independent charter schools operate within district boundaries, up from 179 in fiscal 2012. The district covers approximately 710 square miles, including almost all of the city of Los Angeles and all or part of 25 other cities, as well as providing services to several unincorporated areas of Los Angeles County. The district serves a population of 4.8 million.
TAX REVENUE TO REPAY BONDS VIEWED AS 'PLEDGED SPECIAL REVENUES'
Fitch believes that taxes levied for bond repayment would be considered pledged special revenues under the U.S. bankruptcy code and therefore 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 prepared by outside counsel and provided by the district that provide a reasonable basis to conclude that due to certain state constitutional provisions (primarily Article XIIIA and Proposition 39), which limit and direct the use of pledged property tax revenues dedicated for bond repayment, these revenues would be treated as pledged special revenues in the event of a district bankruptcy.
As a result, Fitch analyzes these bonds as dedicated tax bonds. This analysis focused on the district's economy and its debt burden without regard to the district IDR because Fitch believes that bondholders are insulated from any operating risk of the district.
STRONG DEDICATED REVENUE STREAM
The property taxes levied for bond repayment benefit from the district's huge, resilient, and diverse tax base. This tax base experienced just one year of assessed valuation (AV) decline during the recession (a 2.3% drop in fiscal 2011). Subsequently, AV has grown 22.9% to an all-time high of \\$570.2 billion. The top 10 taxpayers represent only 2% of the district's fiscal 2016 AV.
In terms of future AV growth, there is considerable potential for both new construction and redevelopment of existing properties. This is particularly evident in downtown Los Angeles. The \\$294,515 median AV for single family residences suggests that there is considerable stored value under Proposition 13 that will be released as properties change ownership and taxable AV catches up to market values.
MODERATE DEBT BURDEN
In fiscal 2016, overall debt is moderate on both a per capita basis (\\$3,905) and as a percentage of AV (3.2%). Amortization is moderate at approximately 48% in 10 years.
FINANCES CHALLENGED BY DECLINING ENROLLMENT
The general fund ended fiscal 2015 with a satisfactory unrestricted general fund balance of \\$672.6 million or 10.6% of spending. This represents an improvement from its recent low unrestricted general fund balance of \\$435.7 million or 7.3% of spending in fiscal 2013. Similarly, general fund liquidity was much stronger in fiscal 2015 and the district did not need to issue tax revenue anticipation notes (TRANs). Previously general fund liquidity had been much tighter, and the district had issued \\$1.4 billion in two series of TRANs for the period July 2012 to November 2013.
The district is benefitting both from improvements in state funding for education under the local control funding formula (LCFF), and as a recipient of supplemental and concentration funding for targeted students. This is due to its high 83.2% unduplicated count of students who are English language learners, eligible for free or subsidized lunches, or in foster care. Actual revenues grew by 13% during fiscal years 2013-2015, notwithstanding student enrollment declines.
The district is projecting continued general fund strengthening in fiscal 2016 when it expects to increase the unrestricted general fund balance to a much higher \\$922.5 million or 13.7% of spending. However, this is somewhat artificially high. It incorporates \\$218.3 million in one-time monies held in reserve for salary and benefit cost increases. The district expects to contribute that amount towards solving the projected general fund deficit in fiscal 2017. Furthermore, there is a high amount of LCFF monies devolved to schools which remain unspent while each school determines how best to expend its share.
The district's multiyear projections indicate two years of general fund drawdowns in fiscals 2017 and 2018 as costs continue to rise despite marked student enrollment decline. The district expects to close these gaps through expenditure reductions, savings from employee attrition, use of one-time monies, and further state education funding increases. Further, rising health and welfare benefit cost increases will be partially covered by the district's health and welfare reserve (\\$295.1 million as of June 30, 2015).
However, many of the district's expenditure reduction options would be subject to collective bargaining, legislative changes, or external approvals. The district's options will also be constrained by continuing student enrollment declines. During fiscal years 2003-2016, the district lost 209,674 students (a 28.4% drop) during which time approximately 100,000 students moved to 211 independent charter schools within the district. Student enrollment decline is projected to continue at about 2.8% per year due to lower county birth rates and student migration outside of district boundaries or to unaffiliated charter schools, as well as students dropping out (17% versus statewide average of 11%). The district has the largest fiscally independent charter school program in the country, having grown 1,078% since fiscal 2003. This growth trend is likely to continue, if not accelerate in light of a charter school expansion proposal currently being developed by third parties.
RISING RETIREE COSTS
The district participates in two state-funded pension systems, both of which are mandating increasing employer contributions over the next few years to improve their funded ratios. At June 30, 2015, the district's proportionate share of CalSTRS' and CalPERS' net pension liabilities was \\$4.485 billion (assuming 7.6% and 7.5% discount rates, respectively). Using Fitch's more conservative 7% discount rate, the district's proportionate share increases to \\$5.798 billion or a low 1.1% of the district's fiscal 2015 AV.
The district provides relatively generous lifetime other post-employment benefits (OPEBs) to eligible employees and their spouses. There is a significant unfunded actuarially accrued liability of \\$13.6 billion (July 2015 valuation). The district currently has \\$127.9 million held in a trust fund for future OPEB liabilities. It is unclear if the district is prepared to negotiate less generous OPEB eligibility and entitlements in the future.
POINTS OF BUDGETARY FLEXIBILITY
Fitch notes that, during the recession, the district demonstrated its ability to make difficult resourcing decisions by instituting layoffs and furloughs, offering early retirement incentives, negotiating bargaining unit concessions (including work process changes), and increasing class sizes. All of these options remain open to the district as it manages its expenditures in a falling student enrollment environment. However, they might prove harder to implement outside of a recession.
In terms of personnel expenditures, the district is most likely to rely on attrition and managed hiring in the short- to medium-term.
The district enjoys good taxpayer support. Five bond measures since 1997 have received between 63% and 71% support. However, there is no parcel tax.