Fitch Downgrades Moreland School District, CA ULTGOS to 'AA'; Outlook Stable

AUSTIN, Texas--()--Fitch Ratings has downgraded the rating on the following Moreland School District, California ULTGO bonds to 'AA' from 'AA+':

-- $2.1 million, series 2002B, 2002C, and 2002D.

Fitch has also downgraded the district's Issuer Default Rating (IDR) to 'AA' from 'AA+'.

The Rating Outlook is Stable.

SECURITY

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

KEY RATING DRIVERS

The downgrade of the GO rating and IDR to 'AA' reflects concerns raised by Fitch when it assigned a Negative Outlook in July 2015 about reserves, as well as implementation of Fitch's revised criteria for U.S. state and local governments, which was released on April 18, 2016. The revised criteria places increased focus on the adequacy of reserves to withstand an economic downturn given independent revenue control, expenditure flexibility, and revenue volatility.

The 'AA' IDR is based on the district's solid expenditure flexibility, low long-term liability burden relative to its resource base, and Fitch's expectation that the district will maintain strong gap-closing capacity to withstand the moderate recessionary revenue decline indicated by the Fitch Analytical Sensitivity Tool (FAST).

Economic Resource Base

Moreland School District is a K-8 school district located in Santa Clara County, serving an estimated population of 50,640 in the cities of Campbell, Saratoga and western San Jose. The district is largely residential in the heart of Silicon Valley where residents enjoy income levels well above national averages. Recent years have seen strong enrollment growth, supporting ongoing revenue growth based on the state's per pupil funding formula.

Revenue Framework: 'a' factor assessment

In recent years revenues have increased with continued implementation of the state funding formula. Revenue growth has outperformed national GDP. The district is challenged, as are most school districts, by its limited independent ability to raise operating revenues without voter approval, leaving it dependent on the state as the determinant of the level of most of its funding.

Expenditure Framework: 'aa' factor assessment

The natural pace of spending is likely to remain in line with or marginally above revenues. The district's carrying costs of 12.7% of spending are moderate.

Long-Term Liability Burden: 'aaa' factor assessment

The district's overall debt and direct pension liabilities are less than 10% of personal income.

Operating Performance: 'aa' factor assessment

The 'aa' operating performance assessment reflects the district's strong gap-closing capacity relative to Fitch's expectations of revenue sensitivity. Budget management is solid and includes strong state oversight of budgeting and multi-year planning.

RATING SENSITIVITIES

FINANCIAL PERFORMANCE: The 'AA' rating could come under downward pressure if the district fails to maintain satisfactory financial flexibility. Upward rating action is unlikely given the district's inability to independently raise revenues.

CREDIT PROFILE

As with most California school districts, the bulk of the district's operational revenues are derived from a state-determined per-pupil funding formula. Student average daily attendance of 4,848 is an increase of 24% since fiscal 2008. An additional 3% increase to 4,975 students is estimated for fiscal 2016.

Revenue Framework

The district's revenues are relatively diverse, including parcel taxes ($1.5 million or about 3% of revenue) and facility lease revenues ($5.8 million, or about 13% of revenues) in addition to the funding provided through the Local Control Funding Formula (LCFF) established by the state. These additional and stable-to-growing revenues have resulted in less revenue volatility than California school districts that are more reliant on the state funding formula.

Historical revenue growth has outperformed U.S. GDP. Future revenue growth is determined by overall state revenue performance as well as the factors that determine funding under the LCFF, which include average daily attendance (ADA) as well as the proportion of students that are English language learners, eligible for free or reduced priced lunch, or are foster students ('unduplicated count'). The district's unduplicated count stands at approximately 40% which is relatively low and means the district will not benefit as much from the LCFF allocation as districts with higher unduplicated counts.

Fitch expects revenue growth to continue to be strong given the district's historical performance and trend of enrollment growth. Fiscal 2013, 2014, and 2015, recorded ADA percentage increases over the previous fiscal years of approximately 1%, 6%, and 3%, respectively. The district estimates an additional 2%-3% increase in fiscal 2016 figures (final figures are not yet available). As a conservative budgeting practice the district budgets for flat enrollment growth in the current fiscal year. The increase in general fund LCFF funding from fiscal 2014 to 2015 was 12.4%, and estimated at 14.1% in fiscal 2016.

California's proposition 13 requires a vote of the people to raise taxes and the district has no other independent ability to raise revenues.

The district's revenue base benefits from a parcel tax and revenues derived from the leasing of surplus property. In May 2009, voters approved a special parcel tax for eight years. Voters approved renewal and increase of the tax in June 2016 to approximately $1.5 million, or 3% of revenue. In addition, the district has several long-term leases for surplus property, which in fiscal 2014 generated about $5.8 million or 13.8% of general fund revenue.

Expenditure Framework

Personnel costs for teachers and staff comprise the vast majority of district expenditures.

Fitch expects expenditure growth to be in line with, to moderately above, expected revenue growth based on the district's current spending profile.

The district's mandate to provide educational services places some limitations on its ability to make expenditure reductions in the event of a revenue decline. Nonetheless, the district has solid expenditure flexibility to make necessary cuts if needed. The current student-teacher ratio in the district is 24:1 for grades kindergarten through three, seven students below maximum capacity mandated by the state. This allows the district to consolidate classes and reduce personnel. In addition, the district typically negotiates three-year labor contracts which include adjustments in the event enrollment falls below expectations. Carrying costs are moderate at 12.7% of governmental spending.

Long-Term Liability Burden

The district's combined debt and pension liabilities are 9% of personal income with no expected additional debt issuance in the medium term. The district participates in both CalPERS and CalSTRs. The Fitch adjusted ratio of assets to liabilities for its pension plans is 73.7%. The district's liability related to other post-employment benefits (OPEBs) is only 0.1% of personal income.

Operating Performance

The district's revenues came under pressure due to state funding cuts during the recent economic downturn, but the district used categorical funding flexibility, federal stimulus funding, and the proceeds of the parcel tax to build up precautionary reserves over the period, while making meaningful cuts to reduce expenditure pressures.

The district has strong gap-closing capacity despite having reduced reserves in recent years. The district passed a resolution in fiscal 2016 to increase 'economic uncertainty' reserves to 6%, double the state-required 3% level. Unrestricted reserves are currently at 8%. Fitch believes the district will preserve at least the current level of reserves throughout economic cycles.

The state's school fiscal oversight regime (commonly referred to as AB 1200) results in generally conservative budgeting and multiyear forecasting and includes review of interim and other financial reports and, in cases of severe fiscal stress, appointment of a state trustee.

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

In addition to the sources of information identified in the 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/site/re/879478

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Fitch Ratings, Inc.
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Director
111 Congress Avenue
Austin, TX 78701
or
Secondary Analyst
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Senior Director
or
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Contacts

Fitch Ratings, Inc.
Primary Analyst
Nancy Rocha, +1-512-215-3741
Director
111 Congress Avenue
Austin, TX 78701
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, New York
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com