Fitch Rates Cleveland Muni Sch Dist, OH's Qualified ULTGO Sch Improv Rfdg Bonds 'AA'; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned the following program rating to Cleveland Municipal School District OH's (CMSD, or the district) unlimited tax general obligation (ULTGO) qualified school improvement refunding bonds:

--$10,255,000, series 2013A at 'AA'.

In addition, Fitch assigns an underlying rating of 'A-' to the series 2013A bonds.

The bonds are expected to sell via competitive sale on Dec. 19, 2013. Proceeds are being used to refund outstanding series 2004 bonds.

In addition, Fitch affirms the following ratings:

--Outstanding GO bonds, series, 2004, 2010, 2011, and 2013 underlying rating at 'A-'.

The Rating Outlook is Stable for the program and underlying ratings.

SECURITY

The bonds are voted general obligations of the district secured by the district's unlimited ad valorem tax pledge.

The Ohio School District Credit Enhancement Program requires the Ohio Department of Education (ODE) to forward state foundation program payments to the bond registrar if, prior to the bond payment date, the district has not transmitted funds sufficient to cover required debt service payments.

KEY RATING DRIVERS

IMPROVING BUT STILL STRAINED FINANCES: Pro-active management in reducing expenses combined with the approval of a new property tax levy in Nov. 2012 has provided some financial flexibility with reserves increasing to an adequate level in fiscal 2013. However, Fitch believes finances will continue to be strained as a result of declining enrollment.

DIVERSE ECONOMY SLOWLY RECOVERING: The economy has diversified away from manufacturing to the more stable and strong health and education sectors. The recovery from the recession has been slow but economic development is notable with several significant projects recently coming on line and others currently in progress.

BELOW-AVERAGE ECONOMIC INDICATORS: The district continues to struggle with declining population and enrollment, low wealth indices, above average unemployment, and weak property tax collection rates.

MANAGEABLE DEBT PROFILE: Debt to full value is above average but carrying costs are manageable. An increase in the debt burden reflects the decline in property values due to a sexennial revaluation in 2012. A large potential bond issue in late 2014 could further weaken the debt profile.

STRONG PROGRAM ESSENTIALS: The bonds qualify for the Ohio School District Credit Enhancement Program, which is characterized by stringent requirements and strong program mechanics.

RATING SENSITIVITIES

LONG-TERM STRUCTURAL BALANCE: Fitch believes that the long-term structural balance and the building of reserves to stronger levels will remain challenging. Continued cost cutting in alignment with enrolment declines, successful implementation of the transformation plan and continued voter support for tax levies remains essential to the district's financial health.

CREDIT PROFILE

Of the district's area of approximately 82 square miles, 99.3% is located within the City of Cleveland (GO bonds rated 'A+' with a Stable Outlook by Fitch).

Large declines in enrollment have plagued the district due primarily to the declining city population, the expansion of charter and private schools, and weak academic performance. Average daily enrollment for 2013-14 is estimated at 38,400, a decline of 2% from 2012-13. Enrollment has declined by 44% since 2003-04 and is projected to decline by an additional 11% by 2018. Conversely, charter schools have experienced significant growth in enrollment, increasing to 19,100 students in 2013-14, or 86% since 2003-04. The district's five-year forecast projects continued enrollment growth for charter schools.

SOME POSITIVES UNDER TRANSFORMATION PLAN

In July 2012, the Governor signed education reform legislation for the district known as 'The Cleveland Plan' (the transformation plan).

The legislation provides the district greater flexibility and more authority in how teachers are evaluated and allows the district to intervene in lower performing schools, reassign teachers and require them to work more hours, outside of the confines of labor agreements. Additionally, the district has the legally authority, via agreements, to share state funds with high quality charter school partners.

Several positives have occurred since implementation of the transformation plan. In May 2013, The Cleveland Teacher's Union ratified a 3-year contract by 71% of voting members. Wage increases of 4%, 0% and 1% in 2014, 2015 and 2016, respectively, were offset by a longer teacher work day, increased instructional time, differentiated compensation, flexible work rules, discontinuance of the step and lane system, and health care concessions. Additionally, the district selected nine transformation schools to pilot school-wide autonomy and the governor's fiscal 2014-15 biennial budget included $6 million to further the district's transformation efforts.

NEW TAX LEVY PROVIDES TEMPORARY BUDGET RELIEF

In November 2012, district voters passed a four-year (collection through 2016) 15-mill property tax levy to support the transformation plan. Fourteen mills are allocated to the district and one mill is allocated to partnering charter schools. Based on 2013 assessed value and current property tax collections, the levy generates approximately $66 million (10% of 2013 general fund revenues) annually for the district. Of this, $4.4 million is distributed to charter school partners.

Fitch views the approval of the tax levy positively despite being temporary, as it provides near-term ability to shore up reserves, meets funding needs of an important educational initiative, and shows strong community support. Fitch also recognizes the past experience of CMSD as well as other OH school districts, which shows that renewal or replacement levies have a higher success rate than new levies, better positioning CMSD should it seek extension of the 15- mill levy. Positively, with the exception of the 15 mill levy, property tax revenues are derived from non-expiring levies.

IMPROVING BUT STILL STRAINED FINANCES

The district's strong and experienced management team has taken aggressive steps over the past few years to address the budget imbalance by successfully implementing sizeable spending reductions including the closing of schools, the elimination of teaching positions and labor union concessions.

Primary support for operations comes from state foundation aid at 69% of general fund revenues, followed by property taxes, which provide 28%. In July 2013 House Bill 59 was enacted into law, changing the components of the state funding formula for public education. The district will not benefit under the new formula. Fitch expects declining enrollment will continue to strain the district's revenues as the new funding formula is largely dependent on enrollment numbers. Additionally, the increasing number of students attending charter schools has and will continue to negatively impact state funding. The district receives state funding for students who are residents of the district and attend charter schools with such aid transferred to the charter schools for operations. In 2013 the amount transferred was $127.1 million and is expected to increase to $139.7 million in 2014.

For fiscal 2012 (year-end June 30), the district reported a general fund operating deficit after transfers of $6.4 million (1% of spending). The unrestricted (sum of committed, assigned and unassigned) general fund balance totaled $10.3 million or a weak 1.6% of spending

Draft unaudited GAAP financial statements for year-end June 30, 2013, show improvement due to the new property tax levy and lower instruction costs. The district recorded a general fund operating surplus after transfers of $28.4 million. The unrestricted general fund balance totalled $37 million or an adequate 5.8% of spending.

ONGOING STRUCTURAL BALANCE DEPENDENT UPON VOTER SUPPORT

The district's October 2013 five-year (2014-2018) cash-basis forecast projects budgetary pressures with annual deficits starting in 2015. Unencumbered cash balances remain positive through 2016 with a $73 million cash deficit projected in 2017, increasing to a large $210.5 million deficit in 2018 (28% of expenditures). The forecast does not include revenues from new or renewal tax levies.

The 15 mill levy is for four years to provide for accountability, allowing voters to evaluate whether the district is succeeding under the transformation plan and if tax dollars should continue. In November 2016, a Presidential election year, the district expects to position the levy as either a renewal of the 15 mills or a replacement levy, which if assessed values go up, would allow for an adjusted millage levy and additional dollars.

The district has been successful in securing renewal levies, but it has encountered multiple ballot failures for new levies that are necessary to keep pace with inflation and growing costs. Fitch remains concerned that the general low level of voter support for new levies introduces an element of risk to future revenue streams. The district anticipates placing a bond issue or a combination bond issue and permanent improvement levy on the ballot in Nov. 2014, which may further compromise the ability to renew the 15 mill levy in 2016.

DIVERSE ECONOMY BUT WEAK SOCIOECONOMIC INDICATORS

The economy has diversified away from manufacturing to the more stable health and education sectors but, continues to feel the effect of the sluggish economy as evidenced by weak economic trends and indicators. Cleveland continues to lose population, unemployment rates are above average, poverty rates are more than double the state and nation, income levels are well below average, and property tax collections remain weak.

Cleveland's employment and labor force numbers remained fairly flat from August 2012 to August 2013. The year-over-year unemployment rate decreased to 9.3% from 9.9% as employment increases (0.1%) slightly outpaced the labor force (decline of 0.6%). August 2013 unemployment rates were well above both the state (6.9%) and national (7.3%) rate.

TAX BASE STABILIZING AFTER REVALUATION

The tax base has contracted over the last few years with 2013 assessed value totaling $4.9 billion, a 14% decline from 2012 and an 18% decline since 2009. Fitch believes the tax base has stabilized given the decline was primarily due to a county-wide sexennial revaluation in 2012 and the phase-out of tangible personal property which is now complete. Management reports that 2014 assessed value is up slightly from 2013. The tax base is diverse, with the top 10 taxpayers comprising 12% of assessed value. Total property tax collections have improved, but Fitch still considers them weak, averaging about 88% over the last three years.

MANAGEABLE DEBT PROFILE

The district's debt profile is characterized by an above-average debt to full value of 6.1% reflective of reduced property values, but a more moderate debt per capita of $2,163. The district is contemplating the issuance of approximately $200 million in bonds in 2014 to fund the remaining segments of its master facilities plan. This could weaken the debt profile, but Fitch expects the debt burden to remain manageable given rapid amortization (76% retired in 10 years) and moderate carrying costs.

The district contributes to the School Employees Retirement System (SERS) and the State Teachers Retirement System (STRS), both multiple-employer defined pension plans. The District is required to make contributions in accordance with rates established by the state and has annually met the annual contribution, although this has not always equaled the actuarially required contribution (ARC). STRS' funding level is weak at 56% (estimated by Fitch at 52% when adjusted to a 7% rate of return). Recently enacted state pension reform measures should lessen this risk by improving the funding ratio over the medium term. Fitch considers carrying costs to be moderate with debt service, pension and OPEB claiming 15.9% of 2012 government fund spending.

STRONG PROGRAM ESSENTIALS

The 'AA' program rating is based on the qualification of the series 2013A bonds for participation in the Ohio School District Credit Enhancement Program. Participation requirements are stringent, including 2.5 times coverage of maximum annual debt service by unrestricted state foundation aid on proposed bonds and any outstanding obligations covered by the program. Fiscal year 2014 estimated state foundation aid to the district is 9.3 times maximum annual debt service, well above the required 2.5 times.

Program mechanics are strong. Ohio law requires the Ohio Department of Education (ODE) to forward to a bond paying agent or registrar state foundation payments otherwise due to a participating school district if, prior to the bond payment date, the district has not transmitted funds sufficient to cover a required debt payment. For more information on the Ohio School District Credit Enhancement Program, see Fitch's report dated April 26, 2013 at www.fitchratings.com.

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, University Financial Associates, CoreLogicCase-Shiller Index, IHS Global Insight, Zillow.com and, National Association of Realtors.

Applicable Criteria and Related Research:

--'Tax-Supported Rating Criteria', dated Aug. 14, 2012;

--'U.S. Local Government Tax-Supported Rating Criteria', dated Aug. 14, 2012.

Applicable Criteria and Related Research:

Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

U.S. Local Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=811832

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Contacts

Fitch Ratings
Primary Analyst
Karen Wagner
Director
Fitch Ratings, Inc.
+1-212-908-0230
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Arlene Bohner
Director
+1-212-908-0554
or
Committee Chairperson
Amy Laskey
Managing Director
+1-212-908-0568
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526 (New York)
elizabeth.fogerty@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst
Karen Wagner
Director
Fitch Ratings, Inc.
+1-212-908-0230
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Arlene Bohner
Director
+1-212-908-0554
or
Committee Chairperson
Amy Laskey
Managing Director
+1-212-908-0568
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526 (New York)
elizabeth.fogerty@fitchratings.com