Fitch Ratings affirms the following Santa Ana Unified School District, California (the district) general obligation bonds (GOs) at ‘A+’:
–$ 26.2 million (election of 1999) series 2002B.
The Rating Outlook remains Negative.
SECURITY
The bonds are secured by an unlimited ad valorem tax on all taxable property within the district.
KEY RATING DRIVERS
STATE REVENUE IMPROVEMENTS; UNCERTAINTIES REMAIN: The Negative Outlook reflects the possibility of another operating deficit in fiscal 2015, despite current positive projections. Wage pressure may offset an expected substantial rise in state revenues.
CONTINUED DEFICITS: Despite recent revenue improvements, fiscal 2014 is expected to end with a fourth consecutive operating deficit, reducing the unrestricted general fund to a small 4% of expenditures.
LACK OF EXPENDITURE CONTROL: The district relied on one-time resources and reserves rather than spending cuts to bridge budget gaps over the last few years when revenues were falling.
MIXED ECONOMIC PROFILE: Santa Ana’s economy is mature and diverse, benefiting from its good transportation links to many large regional employment centers. However, the city’s income, poverty and unemployment levels are weak.
ADEQUATE DEBT PROFILE: The district’s debt profile is weakened by slow debt amortization and its participation in the poorly funded CalSTRS pension system. However, the debt ratios are moderate, carrying costs are low, and capital needs are limited.
RATING SENSITIVITIES
STRUCTURAL BALANCE: A negative rating action is possible if operating deficits persist beyond the current fiscal year, further depleting fund balances.
CREDIT PROFILE
The district, the largest school district in the county and one of the largest in California, comprises most of the city of Santa Ana (30 miles south west of Los Angeles) and portions of Irvine, Newport Beach, Costa Mesa, Orange, and Tustin. The district operates 36 elementary schools, nine intermediate schools, and 10 high schools. As is common with many mature, coastal communities in California, the aging of the district’s population has resulted in a gradual decline in enrollment that is forecast to continue through fiscal 2016 at a moderate rate of less than 1% annually.
CONTINUED STRUCTURAL IMBALANCE; BETTER FUNDING PROSPECTS
As Fitch had anticipated, the district continued to incur operating deficits as its financial policies shifted to maintenance of service levels at the expense of what Fitch considers a prudent financial cushion. General fund operations in fiscal 2013 incurred a $34.8 million (7%) deficit, lowering the unrestricted general fund balance to 7.7% of expenditures from a more prudent level of 18.2% two years ago. Current projections for fiscal 2014 point to another $18 million (3.6%) operating deficit, which will further reduce the unrestricted general fund balance to 4% of expenditures.
Planned expenditure reductions in fiscal 2014 were not carried out due to higher than expected state revenues and improved revenue prospects in the out-years. The district expects $14 million (3%) additional state revenues in fiscal 2014 compared with 2013, and even more in the out-years: $41.8 million (9% growth) and $57.5 million (12%) additional revenues in fiscal 2015 and 2016, respectively. This is a result of improved state finances, passage of Proposition 30 and the new local control funding formula (LCFF), which allocates extra funding to certain disadvantaged students. The district has 93% of such targeted students and hence benefits more from LCFF than most districts.
FINANCIAL UNCERTAINTIES REMAIN
As a result of improved revenues, the district currently projects small operating surpluses and a moderate improvement in unrestricted fund balance in fiscal 2015 and 2016. Although the district generally budgets conservatively on the revenue side, and has built in wage, benefit and staffing level increases in financial projections, Fitch is concerned that its financial position may not improve or even worsen. The district is in the process of negotiating with labor unions, which have demanded significant salary increases to compensate for the recession years. Pending that settlement, the actual expenditures in fiscal 2015 and beyond could be substantially higher than currently projected. An unfavorable settlement could result in operating deficits in fiscal 2015 and beyond.
Although the district maintains a reasonable amount of expenditure flexibility (full length school year and many programs), Fitch is concerned about the district’s willingness to rein in expenditures if revenues and/or expenditures underperform expectations. The district avoided painful cuts during the recession to maintain services, allowing general fund expenditures to grow by 8% from 2010 to 2012. The district has also explicitly stated that it is managing to the legally required minimum fund balance target of 2%, while most of its peers have higher implicit or explicit reserve targets. Fitch is concerned if the district budgets expenditures to spend down reserves to the 2% level, it leaves very little room for margin of error, should there be cost overruns or disappointing revenues. If the reserve falls below 2%, Fitch will likely take negative rating action.
POSITIVE CERTIFICATION; IMPROVED LIQUIDITY
The district obtained a positive certification for its fiscal 2014 second interim from the county office of education, an upward revision from the qualified certifications that the district had from 2011 until recently, meaning the county now deems the district able to meet its financial obligations over a multi-year period based on projections. As a result, the district no long needs to work with the county appointed fiscal advisor who provided financial advice.
Dependence on state funding coupled with state funding deferrals caused the district to need cash flow borrowing of up to $80 million (18% of revenues) in one year in the form of tax and revenue anticipation notes and county loans. Since the state began repaying deferrals, the district expects a smaller amount of borrowing of around $35 million (7% of fiscal 2014 spending) for fiscal 2015.
BELOW AVERAGE LOCAL ECONOMIC CHARACTERISTICS
Santa Ana’s economy is well-diversified and enjoys good transportation options to the employment centers in the counties of Orange, Los Angeles and San Diego. Top employers include large theme parks, universities, hospitals, Boeing, Bank of America, and restaurant chains.
However many local economic indicators are below average. The city’s unemployment rate at 9.1% in November 2013 was higher than the national average of 6.6% despite recent employment gains. Per capita income and educational attainment levels are substantially below national averages, while poverty rates are elevated.
Assessed values (AV) fell by a cumulative 12% during the recession but started to recover in fiscal 2013. Zillow indicates a 15.3% year-over-year growth in house prices, suggesting further strengthening in AV can be expected.
MODERATE DEBT; CONCERN OVER CALSTRS
The district’s overall debt is moderate at $2,513 per capita, or 2.7% of AV. Direct debt amortization is slow due to significant use of capital appreciation bonds. After heavy bond issuances between 2008 and 2010, the district reports limited unmet capital needs. The district has no remaining bond authorization, and does not plan on additional issuances in the near term.
The district participates in CalPERS for classified staff and the poorly funded CalSTRS pension system for teachers, as do all school districts in the state. CalSTRS contribution rates are set by statute and have not been increased to reflect the weak investment return environment over the past several years. The system’s funded ratio has fallen to a low 67% or an estimated 63.5% when adjusted by Fitch to reflect a 7% investment return. Future contribution rates will need to rise substantially from current levels and Fitch believes districts would likely bear at least part of the burden.
The district’s other post-employment benefit (OPEB) liability is $120.5 million, or 0.5% of district AV. Fiscal 2013 total debt service, pension and OPEB carrying costs are equivalent to an affordable 9.1% of total governmental spending. Fitch expects carrying costs to remain affordable despite the potential increase in pension costs.
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, National Association of Realtors, and Zillow.
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=825631
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