Fitch Downgrades Duval County School Board, FL's IDR to 'AA-'; Outlook Stable

NEW YORK--()--Fitch Ratings has downgraded the following Duval County School Board ratings:

--Issuer Default Rating (IDR) to 'AA-' from 'AA'.

In addition, Fitch has downgraded the rating on $329 million outstanding certificates of participation (COPs), series 2007, 2009A, 2009B, 2013A, 2015B, and 2016A to 'A+' from 'AA-'.

The Rating Outlook is Stable.

SECURITY

The COPs are payable from lease payments made by the Duval County School District (the district) to the trustee pursuant to a master lease purchase agreement. Lease payments are payable from legally available funds of the district, subject to annual appropriation. The district is required to appropriate funds for all outstanding leases on an all-or-none basis. In the event of non-appropriation, all leases will terminate, and the district would, at the trustee's option, have to surrender all lease purchased projects for the benefit of owners of the COPs that financed or refinanced such projects.

KEY RATING DRIVERS

The one-notch downgrade of the IDR reflects the implementation of Fitch's revised criteria for U.S. state and local governments, which was released on April 18, 2016, and deterioration in the district's financial cushion resulting from operating deficits. The revised criteria place increased focus on growth prospects for revenue and reserve levels relative to expected volatility. The downgrade of the IDR to 'AA-' reflects the district's prospects for slow enrollment-driven revenue growth, very limited legal ability to independently raise revenues, a low long-term liability burden and adequate reserves that have declined in recent years and may be sensitive to cyclical economic declines.

The 'A+' rating on the COPs is one notch below the IDR, reflecting the slightly higher degree of optionality associated with lease payments subject to appropriation.

Economic Resource Base

The local economy is stable, anchored by the presence of the U.S. Navy, and trade activity at the Port of Jacksonville. The district's population has grown at a modest pace, totaling nearly 6% since 2010. Enrollment of about 118,000 students represents a steady decline over the last decade due to a growing charter school presence.

Revenue Framework: 'bbb' factor assessment

District general fund operations are funded through a state formula based on enrollment, which includes a combination of state aid and local property taxes. The slow revenue growth of the last decade is expected to continue, despite a somewhat improved state funding environment, as the district is likely to see further modest enrollment declines in the near term. The district has very limited legal ability to raise revenues.

Expenditure Framework: 'aa' factor assessment

Instructional costs are the main driver of expenditures and are expected to rise in line with to marginally above revenues absent policy action. The district has ample legal control over workforce decisions and very low carrying costs related to debt service and retiree benefits obligations.

Long-Term Liability Burden: 'aaa' factor assessment

The district's long-term liability burden is low and it participates in the adequately funded Florida Retirement System (FRS).

Operating Performance: 'a' factor assessment

Historically, the district keeps reserves above its policy of 3% of spending, though rising operating costs have resulted in declines in recent years. The district's lack of independent revenue flexibility limits its budget flexibility and thus gap-closing capacity in times of economic stress.

RATING SENSITIVITIES

FINANCIAL FLEXIBILITY: A shift that results in a reduction in the district's financial resilience and gap-closing ability could result in downward rating pressure. Conversely, Fitch could consider an upgrade should there be a sustained improvement in the district's overall financial flexibility beyond current expectations.

CREDIT PROFILE

The area's diverse economic base is bolstered by its historical naval presence, large cargo port, insurance, health care, and manufacturing industries. Population growth has been consistent over the last decade, and resident employment and wealth levels have tracked state and national averages and the county's real estate market has rebounded from recessionary lulls. Traditional school enrollment performance has experienced consistent modest declines due to a rapidly growing charter school presence.

Revenue Framework

The Florida Education Finance Program (FEFP) is the primary mechanism for funding the operating costs of Florida school districts. The FEFP process determines a base per-student funding level. The funding is split between state funds largely derived from statewide sales tax revenue, and local funds via the required local millage rate established pursuant to state statutory procedure.

Discretionary taxes for operations and capital/maintenance are also levied by the district up to the statutory maximum rates of 0.748 mills and 1.5 mills, respectively. State aid made up about 62% of the district's fiscal 2015 revenues (prior to transfers in), with about 38% generated by property taxes.

Fitch's view of school district revenue prospects considers the revenue performance of the state as a starting point given its fundamental responsibility for public education funding. Fitch believes Florida's revenue prospects will grow at a pace that is above the rate of inflation but below U.S. economic performance based on a resumption of population growth and stronger economic expansion. School district revenue expectations are somewhat tempered by the state's education funding commitments, which have been variable in recent history, with annual changes in the base student allocation as low as a 1% increase for fiscal 2017. Enrollment trends and expectations are the second key determinant of a school district's revenue growth prospects and are based on Fitch's view of the local economy, demographic patterns, and competition from non-traditional public schools, among other factors. Fitch anticipates district revenues to perform in line with inflation in future years, reflecting the district's ongoing modest enrollment declines and growing charter school presence.

Due to the state funding mechanism, Florida school districts have very limited ability to independently increase general fund revenues. However, this limitation as a factor in the revenue framework assessment is somewhat offset by the recognition of K-12 education as fundamentally a state responsibility and the strong foundation of state support for education funding.

Expenditure Framework

School instruction costs related to personnel constitute the vast majority of district spending. Spending increases are the result of state mandates regarding classroom size, rising salary and benefit costs and other program requirements from the state. The district has a solid level of spending flexibility with ample legal control over workforce and low carrying costs associated with retiree benefits.

Fitch expects the pace of spending to generally match or slightly exceed revenue trends, as increased spending is funded by a similar rise in state funding and growth in local revenues.

Wages and benefits are collectively bargained and the district has relatively good control over employee-related expenditures through the ability to ultimately implement a contract after non-binding arbitration. The district is currently meeting class size requirements in all schools.

Carrying costs related to debt service, pensions and OPEB are low at roughly 8% of fiscal 2015 total government spending, driven largely by debt service costs. Carrying costs are not expected to rise in the near future, as the district has limited borrowing plans and participates in the adequately funded Florida Retirement System (FRS). The district provides a retiree health insurance subsidy, which it funds on a pay-as-you-go basis.

Long-Term Liability Burden

The district's fiscal 2015 combined long-term liability burden, comprising debt and the district's share of the net pension liability of the FRS, is low at approximately 8% of resident personal income. The district's slowly amortizing direct debt (roughly 29% of principal retired in 10 years) makes up a modest 13% of the district's combined long-term liability burden. The district has no intermediate-term plans for new money debt and plans to fund near-term capital projects with local capital improvement tax revenues that exceed debt service requirements.

Pensions are provided through the state run FRS and costs are manageable. FRS is well-funded at a reported 86.5% as of July 1, 2015 or an estimated 80.7% when adjusted by Fitch to assume a 7% rate of return, and as such, costs are not expected to increase materially.

Operating Performance

The Fitch Analytical Sensitivity Tool (FAST) indicates a potential revenue decline for the district of 2.5% in a moderate economic downturn in which GDP drops by 1%. Fitch expects the district to respond to such a decline in line with historical patterns, with a combination of spending cuts and reserves used to address revenue shortfalls. Flexibility is somewhat augmented by available balances in the capital projects fund, though these have declined significantly in recent years and would provide a limited degree of additional support.

The district's budget management has been hampered by service demands with the use of reserves to fund district operations. Fiscal 2015 available general fund reserves totaled $100.8 million, or an adequate 10.6% of expenditures and transfers out. The district incurred a deficit in fiscal 2016 (based on unaudited results) of approximately $12 million, or about 1% of spending. The deficit resulted from the planned use of fund balance for district operations and expanded programming. Incorporating the fiscal 2016 drawdown, available general fund balance declines to $85 million, or 8.7% of spending.

The fiscal 2017 general fund budget is just over $1 billion, roughly 6% higher than fiscal 2016 actual spending and includes further fund balance appropriation of approximately $10 million. Fitch expects fiscal 2017 to perform above budget due to conservative budgeting of revenues and a consistent practice of outperforming the expenditure budget.

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
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33 Whitehall Street
New York, NY 10004
or
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Analytical Consultant
or
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Contacts

Fitch Ratings
Primary Analyst:
George Stimola, +1-212-908-0770
Associate Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst:
Maria Coritsidis, +1-212-908-0514
Analytical Consultant
or
Committee Chairperson:
Amy Laskey, +1-212-908-0568
Managing Director
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
New York
elizabeth.fogerty@fitchratings.com