SAN FRANCISCO--()--Fitch Ratings has taken the following action on San Francisco Community College District's (the district) general obligation (GO) bonds:
--$28.1 million 2002 general obligation (GO) bonds (election of 2001, series A) downgraded to 'A-' from 'A'.
The ratings are removed from Negative Watch and assigned a Negative Outlook.
The bonds are a general obligation of the district. The board of supervisors of the city and county of San Francisco (the city) is obligated to levy and collect ad valorem taxes upon all property within the district subject to taxation, without limitation to rate and amount, to pay debt service on the bonds.
KEY RATING DRIVERS
BALLOT MEASURES OFFER REPRIEVE: The recent voter approval of two key ballot measures reduces the threat of mid-year cuts in fiscal 2013 and will boost district revenues over the next eight years. The downgrade to 'A-' reflects the risk of continuing financial challenges despite improved revenues if the district is unable to make substantial expenditure reductions.
POTENTIAL LOSS OF ACCREDITATION: The district is actively engaged in efforts to retain its accreditation, which will require numerous reforms to address a lengthy history of operational dysfunction. The outcomes of a loss of accreditation are unclear, but the most likely scenario would involve a takeover of the district's functions by a neighboring community college district, with no impairment of debt service.
MANAGEMENT CHALLENGES: The threatened loss of accreditation results from the district's longstanding underfunding of administrative functions and a shared governance structure that has reduced management authority and hindered the district's ability to react to changing fiscal circumstances. In order to maintain current operations the district must demonstrate it is in compliance with accreditation standards by March 2013.
FINANCIAL REPORTING WEAKNESSES: Audits of the district's recent financial statements note multiple and recurring material weaknesses in financial reporting, which raise concerns regarding the accuracy of reported financial data and financial management more generally.
STRONG ECONOMY AND TAX BASE: The district is coterminous with the City and County of San Francisco (GO bonds rated 'AA-' by Fitch) and is supported by a resilient local economy and strong tax base.
MIXED LONG-TERM OBLIGATIONS: Direct and overlapping debt levels are moderate but the district faces substantial liabilities for employee pensions and other post-employment benefits.
WHAT COULD TRIGGER A RATING ACTION
FAILURE TO ADDRESS STRUCTURAL IMBALANCE: The district's inability to make progress towards structural balance would create additional downward pressure on the rating.
OPERATIONAL DISRUPTION: Failure to complete an orderly transition in the event of accreditation loss would leave the district unable to continue as a going concern, and likely result in a multi-notch downgrade.
BALLOT MEASURES RELIEVE PRESSURE; FISCAL CHALLENGES REMAIN
The approvals of state Proposition 30 and local Proposition A remove the threat of large mid-year cuts for the district and provide a sizable boost to funding over the next eight years. The district assumed passage of Proposition 30 in its budget for fiscal 2013 and the measure reduces the likelihood of state cuts to community colleges in future years as well. Passage of Proposition A was not assumed in the district's fiscal 2013 budget and is estimated to raise $16 million (equal to 8% of fiscal 2011 revenues) in each of the next eight years.
The district's finances remain severely stressed despite these positive developments and multi-year projections forecast a return to deficit operations by fiscal 2015. The district's budget for 2013 was balanced largely with one-time concessions from employees but large, recurring cuts will be required to restore structural balance. Available fund balances dropped to approximately $4.5 million (2.25% of unrestricted revenues) at the end of fiscal 2012, as compared to a 5% minimum state standard for similar institutions.
Employee benefits have been a significant cost driver for the district, with a 6% compound annual growth rate over the past five years and more generous provisions than similar institutions. In addition, the district employs substantially more teachers and staff per student than its peers. The district's success in attaining structural balance will depend on its ability to reduce employee salary and benefits costs, which comprise approximately 92% of its unrestricted budget.
POTENTIAL LOSS OF ACCREDITATION
The district faces a March 2013 deadline from its regional accrediting commission to show cause for why its accreditation should be continued. The show-cause order follows the district's inability to address concerns first raised by the commission in 2006, and represents the final step prior to loss of accreditation. The district has also been directed to develop a plan of closure in the event its accreditation is not maintained.
Key factors contributing to the threatened loss of accreditation include inadequate administrative leadership, lack of attention to planning and self-assessment, and a failure to react to changing fiscal circumstances. The most likely outcome of a loss of accreditation would appear to be a takeover of the district's operations by a neighboring community college, as has occurred elsewhere in the state. A rating downgrade is likely if the district is unable to successfully manage such a transition.
FINANCIAL REPORTING CHALLENGES
The district's administrative weaknesses are also reflected in its financial reporting. Recent audits have noted multiple deficiencies in internal controls related to financial reporting, increasing the potential for errors in the district's financial statements. The total number of audit findings has declined over the past several years, but the number of material weaknesses, the most severe category of deficiency, has increased. These findings raise concerns for Fitch regarding the accuracy of reported financial information.
STRONG ECONOMY AND TAX BASE
The district benefits from a booming local economy and growing tax base. As of August 2012, year-over-year employment levels had increased by 3.6% and unemployment was close to a full percentage point below the national average and 3 percentage points under the state rate. The city's housing market retained much of its strength through the recession and strong demand from the technology sector has continued to bolster commercial values. Taxable assessed value growth remained positive throughout the recent downturn and grew by 4% for fiscal 2013.
MIXED LONG-TERM OBLIGATIONS
The district's direct long-term debts are limited to its GO issuances, which are funded from voter-approved property tax overrides restricted to this purpose. Overlapping debt levels are elevated at $6,581 per capita, reflecting the small size of the city's population relative to its tax base. Overlapping debt levels are moderate relative to taxable values, at 3.3% of TAV.
The district participates in two state-sponsored pension plans in addition to a plan sponsored by the city of San Francisco. Total pension costs are manageable at about 7% of unrestricted general fund spending, but are likely to increase in coming years to offset recent investment losses and low funding ratios. OPEB costs are funded on a pay-as-you-go basis, resulting in a growing liability for these benefits.
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, National Association of Realtors, Financial Crisis & Management Assistance Team/California School Information Services, and the Accrediting Commission for Community and Junior Colleges/Western Association of Schools and Colleges.
Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria' (Aug. 14, 2012);
--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 14, 2012).
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
U.S. Local Government Tax-Supported Rating Criteria