Fitch Affirms Modesto City School District, CA's GOs at 'AA-'; Outlook Revised to Negative

SAN FRANCISCO--(BUSINESS WIRE)--In the process of routine surveillance, Fitch Ratings has affirmed the following Modesto City School District, CA (the district) bonds:

--$16 million general obligation (GO) bonds at 'AA-'.

The Rating Outlook has been revised to Negative from Stable.

RATING RATIONALE:

--The Negative Outlook reflects concerns that the district's financial position may decline materially by fiscal 2013 as the result of a challenged state funding environment, expected cessation of one-time federal revenues, and recently strained relations with the district's certificated labor group that could hamper expenditure flexibility.

--The district's financial profile currently is sound but vulnerable. Fund balance levels are good, fiscal 2011 operations are expected to produce a surplus, and expenditure flexibility is adequate in spite of labor issues. However, multi-year projections point to potentially large deficits without further expenditure reductions.

--The local economy is weak, exhibited by high unemployment, below average income levels, and a strained housing market.

--The tax base is well diversified in the top 10 payers, but the weak housing market resulted in a substantial cumulative 17.5% AV drop from fiscal years 2008-2011.

--The district's debt profile is sound. Net debt levels are low, amortization is average, and capital needs are limited.

WHAT COULD TRIGGER A DOWNGRADE?

--A significant revenue decline without sufficient offsetting expenditure reductions, causing the general fund balance to fall to low levels.

SECURITY:

The bonds are secured by an unlimited property tax pledge on all taxable properties within the district.

CREDIT SUMMARY:

Modesto City School District is located in economically stressed Stanislaus County of northern San Joaquin Valley. The district shares a governing board, administration, and a majority of its financial operations with Modesto City High School District, which nonetheless is a legally separate district. As is typical for agriculturally-concentrated economies, economic factors are weak. The city's December unemployment rate rose to a high 15.3% from 15% the year prior, per capita income levels are at just 81% and 87% of state and national averages, and the housing market has been subject to very high rates of foreclosures and price declines during the recession. As a result of real estate pressures, AV dropped by a substantial cumulative 17.5% from fiscal years 2008-2011. These economic pressures resulted in flat to somewhat negative population growth during the housing-led recession, following years of large population increases during the housing boom.

Financial operations currently are sound, but vulnerable to potentially steep funding declines. Fiscal 2011 general fund operations are projected to generate a $5.1 million surplus, raising the total and unreserved general fund balances to good levels of $55.8 million (21.9% of expenditures and transfers out) and $55.1 million (21.6%), respectively. Additionally, management believes its expenditures will be $10 million lower than projected in its second interim report, thus raising fund balances even higher. These positive operating results stem from receipt of one-time federal revenues, and prudent management actions to cut expenditures by $6.5 million in fiscal 2010 and $17.6 million in fiscal 2011. However, federal revenues are scheduled to end in fiscal 2012, and if state-wide taxes are not extended, the district estimates it would lose $9.8 million annually, which would result in an $18.6 million operating deficit in fiscal 2012 without additional expenditure reductions. Further, the operating deficit would widen to $34.7 million in fiscal 2013, unless labor agrees to extend concessions, or without further expenditure reductions. Labor relations recently have been strained, and labor contracts include restrictive class size limits that materially limit expenditure flexibility.

Somewhat mitigating these weaknesses, however, are several programs that could be eliminated by the district (and have already been eliminated by a number of California school districts) that likely would result in substantial savings. However, these savings have not yet been quantified, and probably would not be sufficient, by themselves, to close future projected deficits. If state funding levels are significantly reduced, an inability or unwillingness to sufficiently cut expenditures to offset these losses may result in a downgrade.

The district's debt profile is sound. Direct debt levels are a low $302 per capita, or .6% of AV. Including the debt of overlapping municipal entities, net debt levels are a still low $1,107 per capita, or 2.3% of AV. Debt amortization is average, with 29% and 44% of principal retired in five and 10 years, respectively. Capital needs are limited, and management has no plans to issue debt in the foreseeable future.

Additional information is available at 'www.fitchratings.com'.

In addition to the sources of information identified in Fitch's Tax-Supported Rating Criteria, this action was additionally informed by information from Creditscope and LoanPerformance, Inc.

Applicable Criteria and Related Research:

'Tax-Supported Rating Criteria', dated Aug. 16, 2010;

'U.S. Local Government Tax-Supported Rating Criteria', dated Oct. 8, 2010.

Applicable Criteria and Related Research:

Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=548605

U.S. Local Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=564566

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