Fitch Rates Gilroy Unified School District, CA $60MM GO Bonds 'AAA'; Outlook Stable

SAN FRANCISCO--()--Fitch Ratings has assigned an 'AAA' rating to the following general obligation (GO) bonds to be issued by the Gilroy Unified School District, California:

--$60 million election of 2016, series 2017A.

In addition, Fitch has affirmed the district's Issuer Default Rating (IDR) at 'A+'.

The distinction between the 'AAA' rating on the series 2017A bonds and the 'A+' IDR reflects Fitch's assessment that bondholders are legally insulated from any operating risk of the district.

The Rating Outlook is Stable.

The series 2017A bonds will be sold via negotiation on Jan. 19, 2017. Proceeds will be used to finance specific capital construction, repair, and improvement projects approved by district voters.

SECURITY

The bonds will be repaid from a voter-authorized unlimited ad valorem property tax levied on all taxable property within the district's boundaries.

KEY RATING DRIVERS

SPECIAL REVENUE ANALYSIS: The 'AAA' rating on the series 2017A bonds is based on a dedicated tax analysis without regard to the district's financial operations. Fitch has been provided with legal opinions by district counsel that provide a reasonable basis for concluding that the tax revenue levied to repay the bonds would be considered 'pledged special revenues' in the event of a district bankruptcy.

STRONG ECONOMIC BASE; MODERATE DEBT: The economic resource base supporting the series 2017A bonds is strong and diverse. The unlimited nature of the tax offsets any potential concern about tax base volatility. The district's overall debt is moderate at approximately 4% of the tax base.

IDR REFLECTS UNDERLYING CREDIT: The 'A+' IDR is based on analysis of the district's underlying credit, and incorporates strong gap-closing capacity, moderate historical revenue volatility, and solid expenditure flexibility.

RATING SENSITIVITIES

TAX BASE DRIVES GO RATING: The 'AAA' GO bond rating could come under downward pressure in the event of a significant and prolonged decline in the district's tax base and economy, which Fitch is not anticipating.

IDR SENSITIVE TO FINANCIAL PERFORMANCE: The 'A+' IDR could come under downward pressure if the district fails to maintain strong gap-closing capacity, including reserves sufficient to withstand moderate historical revenue volatility commensurate with the current rating level. Continued revenue gains and increased financial resilience supported by reserves maintained throughout the economic cycle could result in upward rating movement.

CREDIT PROFILE

The 260 square mile district is located in southern Santa Clara County, approximately 30 miles southeast of San Jose, and serves a population of approximately 65,000. The district educates over 11,500 students in kindergarten through 12th grade in 15 schools. Historically, the district was an agricultural and food processing center. However, since it is within commuting distance of Silicon Valley and offers comparatively affordable housing, approximately 69% of its tax base is now residential. Due to housing demand, a number of residential property developments are currently in the permitting and/or construction phases.

After experiencing a 13% decline in fiscal years 2010-2012, taxable assessed value (AV) has more than rebounded by 30% during fiscal years 2013-2017. The district is projecting almost 5% further taxable AV growth in fiscal 2018 due to new construction and existing properties' rising values, and notes that there is stored Proposition 13 value which will be released as longer-held properties are resold. While wealth indicators have tended to be lower than the county and state, they are likely improving as more professional families are attracted to the area because of its comparatively affordable housing.

DEBT SERVICE LEVY VIEWED AS PLEDGED SPECIAL REVENUE

Fitch believes that taxes levied for bond repayment would be considered 'pledged special revenues' under the U.S. bankruptcy code and, therefore, the lien on pledged revenues for the bonds would survive and 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 provided by district counsel specific to the series 2017A bonds. Fitch believes they provide a reasonable basis to conclude that these revenues would be treated as pledged special revenues due to certain provisions of the state constitution (primarily Proposition 13), which limit and direct the use of pledged property tax revenues for bond repayment.

As a result, Fitch analyzes the proposed issuance as dedicated tax bonds. This analysis focuses on the district's economy, tax base, and debt burden without regard to financial operations because Fitch believes that bondholders are insulated from any operating risk of the district. Fitch typically analyzes the ratio of available revenues to debt service for dedicated tax bonds, but the unlimited nature of the tax rate pledge on the district's bonds eliminates the need for such calculation.

STRONG TAX BASE SUPPORTS BONDS

The district's diverse tax base and economy (within commuting distance of Silicon Valley) provide a strong basis for repayment of the series 2017A bonds that is unlikely to be reduced by normal or even severe cyclical fluctuations.

The tax base is growing at a healthy pace after experiencing a 13% decline during the last recession. Taxable AV has risen at a 2.7% CAGR since 2007. Prospects for further growth appear solid based on new construction and rising house prices, while taxpayer concentration is low.

Tax rates are low and unlikely to rise to a level that pressures the rating even under relatively severe economic stress. The general tax rate of 1% of AV is established in the state constitution and cannot be increased. Tax override levies for overlapping jurisdictions are similarly low at a combined 0.2% of taxable AV for fiscal 2016.

IDR EXPANDS ANALYSIS TO INCLUDE OPERATIONS

The 'A+' IDR reflects the district's strong gap-closing capacity supported by reserves consistent with an 'a' category level assessment of financial resilience, moderate historical revenue volatility, and solid revenue growth prospects. As with all other California school districts, there is no independent legal ability to raise revenues without voter authorization. This limitation is partially offset by the district's growing student enrollment, solid expenditure flexibility, and moderate long-term liability burden.

Revenue Framework: 'a' factor assessment

The district's revenues have performed well in relation to overall U.S. economic performance and inflation over the past 10 years. The district's independent legal ability to raise revenues is limited by state constitutional provisions requiring voter approval for tax increases.

Expenditure Framework: 'aa' factor assessment

The natural pace of general fund spending is likely to remain in line with, to marginally above, general fund revenues. Fixed debt and retiree benefit costs are moderate relative to the district's resource base, supporting solid expenditure flexibility.

Long-Term Liability Burden: 'aa' factor assessment

Long-term liabilities for overall debt and pensions are moderate relative to the district's resource base.

Operating Performance: 'a' factor assessment

The district has maintained strong gap-closing capacity. Budget management includes multiyear planning under state oversight. Fitch expects implementation of a 7% reserve policy in fiscal 2017 (already achieved a year ahead of schedule, in fiscal 2016) will support the district in maintaining solid unrestricted general fund balance levels throughout the economic cycle in the future.

Revenue Framework

As with most California school districts, the bulk of the district's operational revenues are derived from a state-determined per pupil funding formula. Future revenue growth under the local control funding formula (LCFF) is determined by overall state revenue performance as well as the district's average daily attendance and unduplicated count of students who are English language learners, eligible for free or subsidized lunch, or in foster care. The district's 58% unduplicated count means that it will continue to benefit from both concentration and supplemental grant funding.

The district's revenues have performed well in relation to overall U.S. economic performance and inflation over the past 10 years. Given projected moderate student enrollment growth and positive trends in state per pupil funding, the district will likely benefit from ongoing solid revenue growth.

As with other California local governments, the district has no independent legal ability to raise revenues due to state constitutional provisions (most notably Propositions 13 and 218) requiring voter approval for tax increases.

Expenditure Framework

Personnel costs for teachers and staff comprise the vast majority of district expenditures. Based on the district's current spending profile, Fitch expects expenditure growth to be in line with, to moderately above, expected revenue growth, in the absence of policy action.

The district's mandate to provide educational services limits its ability to make expenditure reductions in the event of a revenue decline, but Fitch expects expenditure flexibility to remain solid. To address any unanticipated budget gaps, Fitch expects management would likely reduce non-core services and positions, implement furloughs and 0% COLAs, and draw down on the reserves for equipment replacement and a new school. The district has made considerable use of early retirement incentive programs, offering them in each of fiscal years 2010-2014.

The district's multiyear labor contracts facilitate expenditure control, since they typically include contract reopeners for remuneration issues in the second and third years, do not prohibit furloughs or layoffs, and contain no binding arbitration requirements related to remuneration negotiations.

The district's fixed debt and pension carrying costs are moderate at around 15%. The district's pension contributions are rising annually for both pension systems, but should remain in the moderate range.

Long-Term Liability Burden

The district's combined debt and pension liabilities are moderate at around 15% of personal income. The district participates in two state-sponsored pension plans with typical actuarial assumptions. The Fitch-adjusted ratio of pension assets to liabilities is approximately 74%. The district has no other post-employment benefit liability.

In June 2016, approximately 61% of voters authorized $170 million in GO bonds to build a new elementary school and undertake a number of capital repair and improvement projects. The series 2017A bonds are the first issuance against this authorization. Inclusive of the series 2017A bond issuance, the district's direct debt amortization is extremely slow at approximately 18% in 10 years. The district will consider using up the 2016 authorization with further bond issuances of up to $60 million in fiscal 2019 and up to $50 million in fiscal years 2022 or 2023, if AV grows sufficiently (at approximately 5% annually). The district could also issue up to $28 million in new bonds in fiscal 2026 against an earlier unspent voter authorization. Consequently, Fitch expects the district's liability burden to remain moderate for the foreseeable future.

Operating Performance

District operations are typically positive, with the recent exception of fiscal 2014 which had a small net operating deficit after transfers (less than 1% of general fund spending) due to the first salary increases in five years. Despite further remuneration increases, the district has subsequently returned to positive operations, largely due to increased funding under LCFF.

The district posted general fund net operating surpluses after transfers in fiscal years 2011-2013 largely due to expenditure reductions. These included implementing furloughs, reducing school days, increasing employee health care contributions, and providing no salary increases for five years. The district restored the furloughed days in fiscal 2013 and, as noted above, began increasing remuneration in fiscal 2014.

In a 1% GDP decline scenario, Fitch estimates the district would experience a moderate general fund revenue decline of less than 3% based on historical results. Given the need to make all budget adjustments on the expenditure side due to the absence of revenue-raising authority, Fitch assesses the district's gap-closing capacity as midrange. Fitch expects that the district, supported by its solid expenditure flexibility, would make the necessary budgetary adjustments to continue to meet its reserve policy.

District budget management is supported by California's robust Assembly Bill 1200 (AB 1200) school oversight framework, which requires conservative budgeting and multiyear forecasting with oversight from the county office of education.

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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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:
Shannon Groff, +1-415-732-5628
Director
or
Committee Chairperson:
Laura Porter, +1-212-908-0575
Managing Director
or
Media Relations:
Alyssa Castelli, New York, +1-212-908-0540
alyssa.castelli@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:
Shannon Groff, +1-415-732-5628
Director
or
Committee Chairperson:
Laura Porter, +1-212-908-0575
Managing Director
or
Media Relations:
Alyssa Castelli, New York, +1-212-908-0540
alyssa.castelli@fitchratings.com