Fitch Rates South San Francisco USD, CA's $129MM Unlimited Tax GO Bonds 'AAA'; Outlook Stable

SAN FRANCISCO--()--Fitch Ratings has assigned a 'AAA' rating to the following South San Francisco Unified School District (CA) (the district) bonds:

--$124 million 2016 general obligation (GO) bonds (Measure J), series C (dedicated unlimited ad valorem property tax bonds);

--$5 million 2016 GO bonds (Measure J), series D (dedicated unlimited ad valorem property tax bonds - federally taxable).

The bonds are expected to be sold via negotiation on May 25, 2016. Proceeds will be used to refund approximately $128 million of outstanding bond anticipation notes and provide approximately $1 million in new capital improvement funding for school facilities.

Fitch also assigned an Issuer Default Rating (IDR) of 'AA+' to the district.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by unlimited ad valorem property taxes levied on all taxable property within the district. Fitch has been provided with legal opinions by district counsel that provide a reasonable basis for concluding that the tax revenues levied to repay the bonds would be considered 'pledged special revenues' in the event of a district bankruptcy.

KEY RATING DRIVERS

The 'AA+' IDR is based on the district's very strong gap-closing capacity, which is supported by the district's solid revenue growth prospects, strong general fund reserves, and low long-term liability burden. Although the district has very limited discretion over its general fund revenues, they have performed well, and there is considerable upside potential given likely new development. The district also has solid general fund expenditure flexibility.

The 'AAA' rating for the 2016 GO bonds (Measure J), series C and D is based on a dedicated tax analysis without regard to the district's financial operations. The district provided Fitch with legal opinions prepared by outside counsel that provide a reasonable basis for concluding that the property tax revenues levied to repay the bonds would be considered 'pledged special revenues' in the event of a district bankruptcy.

Economic Resource Base

The district is located in northern San Mateo County and encompasses the entire city of South San Francisco (89% of the district's AV). It operates 21 educational facilities providing services to approximately 9,000 students. Historically, the city of South San Francisco has been a predominantly industrial community and 44% of the district's tax base still comprises industrial and commercial properties. This likely influences the city's below-average economic characteristics relative to the Bay Area as a whole. More recently, the city's beneficial location near San Francisco, Silicon Valley, and three major research universities has attracted more than 100 biotechnology and information technology-related businesses, most notably Genentech, a subsidiary of Roche Pharmaceuticals (Fitch long-term IDR of 'AA' for Roche Holding Limited). This business concentration, in combination with the Bay Area's very strong property market, means that the city of South San Francisco has seen considerable assessed valuation growth. Since 2008, the district has been in basic aid status whereby its local property tax revenues exceed the state's minimum funding guarantee. The district maintained its basic aid status throughout the most recent recession.

Revenue Framework: 'a' factor assessment

General fund revenue growth has been in line with national GDP growth and slightly ahead of inflation. The district has very limited discretion over general fund revenues.

Expenditure Framework: 'aa' factor assessment

The rate of spending growth is expected to be in line with, to marginally above, expected revenue growth. The district has solid expenditure flexibility given its moderate carrying costs, high proportion of supplemental staffing for enhanced program offerings, and somewhat flexible labor agreements. There will be some upward expenditure pressure from rising pension system contributions.

Long-Term Liability Burden: 'aaa' factor assessment

The district's overall debt and unfunded pension liability is low relative to its resource base. There are no additional debt issuance plans, but amortization is slow. The district has no plans to prepay its manageable OPEB liability.

Operating Performance: 'aaa' factor assessment

The district has very strong gap-closing capacity supported by its concentrated effort post-recession to increase general fund reserves.

RATING SENSITIVITIES

FINANCIAL OPERATIONS: Fitch expects that the district will continue to exercise sound budget management and maintain solid reserves through the economic cycle.

CREDIT PROFILE

The portion of the district located east of Highway 101 offers considerable commercial development potential of interest to biotechnology and information technology companies. Over the next seven years, the district is expecting construction of 2,300 residential units, downtown revitalization, a relocated and improved Caltrain station, and implementation of ultra high-speed internet throughout the city of South San Francisco. After experiencing 169% AV growth since fiscal 1999, the district is projecting 4% annual AV increases going forward, which is in line with recent annual growth rates. There is considerable stored Proposition 13 value in the district's tax base which is being released as long-held properties turn over. The district reports that the median AV of a single family house in the district is approximately 49% of the median sales price during the first four months of 2016.

There is taxpayer concentration within the district with Genentech representing 10% of the fiscal 2016 tax base. In addition, two related industrial property owners (Slough BTC LLC and Slough SSF LLC), which lease to biotechnology companies including Genentech, represent a further 7%.

In 2010, 77.5% of district voters authorized up to $162 million in GO bonds for capital improvements. The GO bonds, series 2016C and D are the final bond series under that authorization and will repay approximately $128 million of bond anticipation notes and provide approximately $1 million in new funding for capital improvement projects. They are a mixture of current interest and capital appreciation bonds structured to stay within an overall tax rate of $50 per $100,000 of AV, a political commitment of the school board. A slow debt repayment schedule will achieve that goal.

Revenue Framework

For a small subset of California school districts, local property tax revenues result in dollars per average daily attendance (ADA) that exceed the state's revenue limit. Those districts are allowed to keep all their property tax revenue but do not receive any unrestricted general fund monies or statutory minimum aid from the state, only certain state categorical program funding. Consequently, these 'basic aid' school districts are very dependent on local property taxes. While South San Francisco Unified School District has this exposure to its local tax base, its basic aid status provides a significant buffer against state funding volatility and mitigates funding losses associated with declining student enrolment (down 3.4% between fiscal years 2011-2016).

The district's general fund revenue growth has been in line with national GDP growth and slightly ahead of inflation. The district has very limited discretion over general fund revenues since Proposition 13 limits AV growth to inflation (capped at 2%) plus new development.

General fund revenues will likely continue to reflect U.S. economic performance as it impacts the local industrial, commercial, and residential property markets.

The district has no independent ability to raise revenues.

Tax Revenue to Repay Bonds Viewed as 'Pledged Special Revenues'

Fitch believes that taxes levied for bond repayment would be considered pledged special revenues under the U.S. bankruptcy code and therefore would not be subject to the automatic stay (i.e. payment interruption) in the event the district were to file for bankruptcy.

Fitch has reviewed and analyzed legal opinions prepared by outside counsel for the district that provide a reasonable basis to conclude that due to certain state constitutional provisions (primarily Article XIIIA and Proposition 39), which limit and direct the use of pledged property tax revenues dedicated for bond repayment, these revenues would be treated as pledged special revenues in the event of a district bankruptcy.

As a result, Fitch analyzes these bonds as dedicated tax bonds. This analysis focused on the district's economy and its debt burden without regard to the district IDR because Fitch considers bondholders to be insulated from any operating risk of the district. The 'AAA' dedicated tax rating is based upon the district's strong tax base and its low debt levels. Fitch used the district's AV history (fiscal years 1999-2014) as a proxy for the unlimited ad valorem property tax revenue pledge. Revenue volatility, as measured by the Fitch Analytical Sensitivity Tool (FAST) output indicated a revenue sensitivity of -1% for a 1% decline in national GDP. The tax rate can be adjusted to meet debt service as needed given the unlimited nature of the pledge.

Expenditure Framework

Labor costs drive the district's spending and are likely to be in line with or moderately above expected revenue growth based upon existing and anticipated future labor agreements and increasing contributions to CalSTRS through fiscal 2021. Carrying costs are expected to remain moderate despite rising pension system contributions.

The district has three-year contracts with each of its three bargaining units, expiring June 30, 2018. The district absorbed a 5% salary increase in fiscal 2016 and is budgeting to do so again in fiscal 2017. No salary increase is anticipated in fiscal 2018. Currently, the district's teacher salaries are comparable to those in peer districts, and the district has been paying for new teachers' first two years of training.

The district has identified the following areas that Fitch considers offer expenditure flexibility: supplemental staff employed for enhanced programs; expenditures related to contracts, consultants, and attorneys; materials and supply costs; and construction costs. In fiscal years 2010 and 2011, when AV declines resulted in lower property tax revenues, the district reduced headcount. Its multiyear labor agreements are somewhat flexible, particularly because they have annual reopeners permitting renegotiation if revenues change, and the district's average class size (24 students per teacher) is already well below the contractual maximum (29:1).

Long-Term Liability Burden

The district's long-term liability burden is low relative to personal income at 8%. However, amortization of its direct debt is significantly slowed by the accreted interest related to its moderately high use of capital appreciation bonds. The district has no further debt issuance plans and has not issued TRANs since 2012. The district participates in two adequately funded state-run pension plans which will require increased employer contributions over time. The district funds its annual OPEB costs on a pay-as-you-go basis and has a minimal unfunded OPEB liability. However, since there are no plans to pre-fund OPEBs, that liability will likely grow.

Operating Performance

Since the most recent recession, the district has focused on strengthening its general fund reserves which now provide a significant financial cushion against future economic downturns. The district is consistently well above its minimum policy reserve of 5% of general fund expenditures (3% minimum state requirement plus an extra 2% cushion because of the district's basic aid status).

The district has a history of very conservative budgeting, with actual reserves being significantly higher than budgeted levels. As a result, its unrestricted general fund balance grew to $49 million (59% of spending) in fiscal 2015. Fitch expects the district to maintain strong financial flexibility going forward, both in the general fund and in other funds which could support the general fund if needed.

The district projects that its property tax revenues will continue to be supplemented by increasing post-dissolution redevelopment monies, including one-time proceeds from approximately a dozen former redevelopment properties still to be sold. The district uses one-time monies for capital and one-time program expenditures. It received considerable one-time state and post-dissolution redevelopment monies in fiscal years 2013 and 2016. In fiscal 2016, the district transferred $10 million from its general fund to its special reserve fund for capital outlay projects in anticipation of a major school site renovation. The special reserve fund for capital outlay projects' anticipated $11 million balance at fiscal 2016 year end is fully available for general fund purposes, if needed, until it is expended on the anticipated renovation project.

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

In addition to the sources of information identified in Fitch's applicable criteria specified below, this action was informed by information from Lumesis and InvestorTools.

Applicable Criteria

U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=879478

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1004717

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Contacts

Fitch Ratings
Primary Analyst
Alan Gibson, +1-415-732-7577
Director
Fitch Ratings, Inc.
650 California Street, 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Karen Ribble, +1-415-732-5611
Senior Director
or
Committee Chairperson
Amy Laskey, +1-212-908-0568
Managing Director
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Alan Gibson, +1-415-732-7577
Director
Fitch Ratings, Inc.
650 California Street, 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Karen Ribble, +1-415-732-5611
Senior Director
or
Committee Chairperson
Amy Laskey, +1-212-908-0568
Managing Director
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
elizabeth.fogerty@fitchratings.com