Fitch Affirms Menifee USD, California's GOs at 'AA-'; Outlook Revised to Negative

SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'AA-' rating on the following Menifee Union School District, California (the district) bonds:

--Approximately $9.2 million 2002 election general obligation (GO) bonds, series A;

--Approximately $5 million 2002 election GO bonds, series B.

The Rating Outlook is revised to Negative from Stable.

SECURITY

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

KEY RATING DRIVERS

SIGNIFICANT FISCAL STRESS: The Negative Outlook reflects a weakening in the district's fiscal position and ongoing challenges that the district faces in balancing its finances from an existing structural deficit, which could be increased by potential further state funding reductions.

ONGOING BUDGET CHALLENGES: Even if state voters approve the proposed tax rate increase on the November 2012 ballot, the district projects operating deficits that may require potentially difficult cost-cutting measures such as teacher layoffs. Management's willingness to take strong, effective action to address operating deficits in the fiscal year 2014 budget is a key rating concern.

ECONOMIC STABILIZATION: Assessed value appears to be stabilizing after annual declines since fiscal year 2009. County employment trends are positive and unemployment levels continue to decline.

MODERATE DEBT LEVELS BUT SLOW AMORTIZATION: District debt levels are low and capital needs are not significant. However, debt amortization is very slow. The district's other post-employment benefits (OPEB) liability and annual funding requirements are manageable.

WHAT COULD TRIGGER A DOWNGRADE

FINANCIAL DECLINE IN FISCAL YEAR (FY) 2013: The FY 2013 budget indicates a possible reduction of total fund balance to 5%, assuming additional reductions in state funding that could occur depending on the outcome of the state's November 2012 tax proposition. A decline to this level without offsetting expenditure reductions could result in a downgrade.

CREDIT PROFILE

The district serves approximately 8,900 students in the city of Menifee, located in western Riverside County. Historical population and enrollment growth have been strong, given the community's proximity to major employment centers and its relative affordability. Enrollment was affected by recent economic weakening but has shown average growth of about 1% in the last three years.

The district has seen significant housing sector weakness in recent years. Assessed value fell by 18.1% in FY 2010 after a 5% decline in FY 2009. Declines continued in FY 2011 (4.8%), but assessed value returned to growth in FY 2012 (about 2%) and is expected to remain flat for FY 2013. The district reports recent commercial and residential property development, but at a much slower pace than in prior years.

DISTRICT FINANCES WEAKEN IN FY 2012

The district's financial operations were positive in FY 2011, but showed signs of deterioration in FY 2012. Due to the receipt of federal funds and stronger state funding, FY 2011 operations produced a $2.8 million operating surplus, and increased total fund balance to $13.8 million from $11 million in FY 2010. The FY 2011 unrestricted fund balance (the sum of unassigned, assigned, and committed fund balances under GASB 54) was $12.9 million, or 21.9% of expenditures and transfers out. Based on preliminary estimates for FY 2012, the district is expecting an operating deficit of $3.1 million and an unrestricted fund balance that will decrease to close to 2010 levels at $9.7 million (16.1 % of expenditures and transfers out).

DEFICIT EXPECTED IN FY 2013; $4 MILLION WORSE WITH TRIGGER CUTS

The FY 2013 approved budget assumes the impact of trigger cuts to state funding that would occur in FY 2013 if California voters reject a proposed tax increase in November 2012. The budget projects an operating deficit of $7.6 million and an unrestricted fund balance that falls to $2.7 million or 4.4% of expenditures and transfers out. Absent additional measures to achieve budget balance, out-year projections indicate significant operating deficits and erosion of reserves to negative levels.

Even if state voters approve the tax proposal in the fall, district operations would still feature an operating deficit of $3.6 million for FY 2013, based on current estimates. Assuming the tax increase, the resulting FY 2013 ending balance would decline to about $7 million, or 11.4% of expenditures and transfers out. Going forward, the district will still be challenged to resolve projected operating deficits.

SOME EXPENDITURE FLEXIBILITY REMAINS

While the FY 2013 budget includes some modest expenditure reductions related to student transportation spending and furlough days for certain employees, an impasse in negotiations with the teachers' unions has excluded potential savings ($1.9 million) from proposed teacher furlough days. It is unclear if the full savings will be possible in FY 2013, though resolution of negotiations could achieve some further savings based on a lesser number of furlough days than originally proposed.

The school board has not pursued the option of teacher layoffs to date. The district has implemented very few layoffs in recent years. However, management stated that layoffs are a potential option in FY 2014. District class sizes are currently below maximums permitted under labor agreements. Increasing class size to the permitted maximums would allow for 43 teacher layoffs or about $3.2 million in savings. Other potential options for cost savings include further reductions to student transportation spending.

INTERNAL RESOURCES USED FOR CASH FLOW

The district does not have a recent history of debt issuance for cash flow needs. It does, however, rely on internal cash flow borrowing from the capital facilities fund. Borrowing of up to 100% of the fund's balance is legally permitted. The district borrowed $12 million in June 2012, with repayment due in June 2013. Currently available resources are estimated at about $15.5 million. Cash flow estimates for FY 2013, which assume the trigger cuts are implemented, indicate a $17 million loan expected in June 2013. While the district has been able to borrow from available internal funds for cash flow needs, it may have to resort to external cash flow notes if further deterioration in its financial condition requires cash flow borrowing in excess of available capital facilities fund resources or if these resources decline.

MIXED DEBT PROFILE

The district's debt profile is mixed. Net direct debt levels are low at $667 per capita and 0.9% of AV and average when including overlapping debt (about $3,552 per capita and 4.6% of AV). Capital needs are manageable and no additional debt issuance is expected, apart from refunding debt to achieve debt service savings. However, amortization is extremely slow, with just 22% of debt retired in 10 years. Pension costs were a manageable 6% of spending in fiscal 2011. The district's OPEB liability is minimal.

Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

In addition to the sources of information identified in Fitch's Tax-Supported Rating Criteria, this action was additionally informed by information from Creditscope, University Financial Associates, S&P/Case-Shiller Home Price Index, IHS Global Insight, Zillow.com, and National Association of Realtors.

Applicable Criteria and Related Research:

--'Tax-Supported Rating Criteria' (Aug. 15, 2011);

--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 15, 2011).

Applicable Criteria and Related Research:

Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648898

U.S. Local Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648842

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