Fitch Affirms Upper Lake Union High School District, CA's GOs at 'A'; Outlook Stable

SAN FRANCISCO--()--Fitch Ratings has affirmed the 'A' rating on the following Upper Lake Union High School District, CA (the district) general obligation (GO) bonds:

--$1.2 million, series 1999A.

The Rating Outlook is Stable.

SECURITY

The GO bonds are payable from an unlimited ad valorem property tax.

KEY RATING DRIVERS

ADEQUATE FINANCIAL POSITION: The district's financial performance is sound, but variable due to exposure to volatile state funding. The district has shown strong expenditure discipline as it adjusted to enrollment changes that drive state funding.

LIMITED ECONOMY: The rating is limited by the district's narrow, remote and weak economy. Unemployment is high, and wealth levels are low.

LOW DEBT BURDEN; AFFORDABLE RETIREE COSTS: The debt profile is strong with low debt levels, rapid amortization and no plans to issue more debt. Total carrying costs of debt, pensions and other post-employment benefits (OPEB) will remain moderate despite planned pension contribution increases.

SOLID MANAGEMENT PRACTICES: Management has proactively responded to revenue pressures and generally maintained fiscal balance in a very challenging environment. The district benefits from a strong state-mandated financial planning and oversight framework.

RATING SENSITIVITIES

EXPENDITURE DISCIPLINE IS KEY: The rating could move lower if the district were unable to maintain solid reserves and budget balance amid declining enrollment over the next several years. The rating is unlikely to move higher due to the district's limited economy and enrollment volatility.

CREDIT PROFILE

Upper Lake Union High School District is a small, single-school district that serves about 300 students and 8,800 residents in rural Lake County, California. The district is located about 140 miles north of San Francisco at the edge of the Mendocino National Forest.

LIMITED ECONOMY

The district's limited economy and tax base are the primary credit weaknesses. The local economy is dominated by agriculture and tourism, and the region suffers from chronically high unemployment. Lake County's non-seasonally adjusted unemployment rate was 9.5% in December 2014, well above the state (7%) and national (5.4%) rates. District income levels are low with median household income at 50.2% of the U.S. and 43.6% of the state medians. The individual poverty rate is also elevated at 32.2%.

The local tax base is limited, but appears stable. It lost less value than most California communities during the housing downturn because the Upper Lake area did not participate heavily in the housing boom that preceded the bust. District taxable assessed value (AV) fell an aggregate 1.7% through three years of declines from fiscal 2010 to fiscal 2013. AV rose 0.1% in 2014. The tax base is primarily residential and lacks concentration in any single taxpayer or industry with the top 10 taxpayers accounting for just 6.3% of AV.

RELIANCE ON STATE FOR FUNDING

The district is largely dependent on the state of California for funding, and performance is volatile because of significant swings in the district's small enrollment. Enrollment is currently low (down by about a quarter since 2010) after several years of small 9th grade classes. Management has taken prudent steps to reduce expenditures, but has struggled to match revenue declines, yielding a mixture of deficit and surplus years. Results improved significantly in 2014 with recovery in the state funding environment and changes to the per pupil funding formula, which benefit districts with significant numbers of poor students, second language learners and foster children. The district's unduplicated count of students eligible for extra funding is very high at 96%. The district had a net operating surplus after transfers of $275,000, or about 6% of its $4.4 million budget, in the fiscal year ended June 30, 2014.

The district's budget for 2015 appears reasonably balanced, though multiyear projections show a need for continued cost cutting in 2016. District officials believe they are near the low-point in enrollment and tend to have a good grasp of upcoming enrollment due to active tracking of student populations in feeder school systems.

The single-school district's enrollment has traditionally been quite volatile due to its small size, but the district has managed such volatility well. Enrollment declines and related funding loss are difficult to absorb when the district's student body falls to the current level because the district cannot fully offset the funding loss with staffing reductions. The district must provide required college preparatory programming, limiting the number of teachers and subjects it can cut. It is currently down to just 13 teachers. During such periods it tends to draw down reserves built up in better times.

The district is considering a merger with one of the feeder school systems, the Upper Lake Union Elementary School District (not rated by Fitch). The merger could smooth enrollment and revenue volatility somewhat, while providing some economies of scale in administration. But the district is likely to remain fairly vulnerable to enrollment changes even if the merger goes through. The credit impact will depend on the combined board's performance and willingness to continue to exhibit expenditure discipline and to maintain solid reserves to withstand a volatile revenue environment. The merger is still not fully approved, and the districts have not yet presented combined financial statements and projections. The full credit implications of any merger will be assessed when combined financials are available.

The high school district's fund balances have remained in a healthy range despite the difficult revenue environment. The unrestricted fund balance (the sum of assigned, committed and unassigned under GASB 54) was $1 million, or 22.9% of expenditures and transfers out, at the end of fiscal 2014. Management has regularly taken action to maintain an adequate cushion of at least 10% of expenditures, which Fitch views as key to maintaining the current rating level. While the district's fund balances are impressive as a percent of expenditures, the absolute dollar amount of the reserve is rather small, leaving the district vulnerable in the event of major, unforeseen expenses.

VERY LOW DEBT BURDEN

The district's debt profile is strong with the entire debt portfolio composed of fixed-rate, unlimited tax GO bonds. The direct debt burden is quite low at 0.5% of AV. Amortization of the debt is rapid with 75% of principal (including all bond debt) repaid over 10 years. The district has limited capital needs and no further debt issuance planned.

The district participates in two state pension plans, the California Public Employees' Retirement System (CalPERS) and the California State Teachers' Retirement System (CalSTRS). In fiscal 2014, the district contributed 100% of the annually required contribution (ARC). CalPERS contributions are actuarial, but the CalSTRS contributions are statutory and have been below the ARC for several years, contributing to its low funding level and creating the need for significant contribution increases going forward. District CalSTRS contributions will increase to 19.1% of teacher payrolls from 8.25% over seven years. The district's OPEB offerings are minimal and not a major credit concern.

Total carrying costs of debt, pension and OPEB are currently quite moderate at 11.8% of governmental funds spending. Carrying costs would remain a moderate (about 14.1% of spending) even if pension contribution increases were fully phased in 2014. Such an increase will pressure budgets somewhat, but appears quite manageable.

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, S&P/Case-Shiller Home Price Index, IHS Global Insight, the National Association of Realtors, and the Lake County, California Auditor.

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

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=980941

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

Contacts

Fitch Ratings
Primary Analyst
Andrew Ward
Director
+1-415-732-5617
Fitch Ratings, Inc.
650 California St. 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Scott Monroe
Director
+1-415-732-5617
or
Committee Chairperson
Karen Ribble
Senior Director
+1-415-732-5617
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Andrew Ward
Director
+1-415-732-5617
Fitch Ratings, Inc.
650 California St. 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Scott Monroe
Director
+1-415-732-5617
or
Committee Chairperson
Karen Ribble
Senior Director
+1-415-732-5617
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com