|[January 29, 2013]
Fitch Affirms Modesto City High School District, CA's GOs at 'AA-'; Outlook Revised to Stable
SAN FRANCISCO --(Business Wire)--
Fitch Ratings has affirmed Modesto City High School District,
California's (the district) general obligation bonds (GOs) as follows
and has revised the Rating Outlook to Stable from Negative:
--$93.1 million GOs (Election of 2001) series A at 'AA-'.
The bonds are secured by an unlimited property tax on all taxable
property within the district.
SOUND FINANCIAL OPERATIONS: The Outlook revision to Stable from Negative
reflects material and persistent financial outperformance compared to
district projections, an improved revenue outlook, and the expectation
that the district will retain a sound financial cushion over the
WEAK ECONOMY, MODEST IMPROVEMENTS: The local economy continues to show
signs of weakness, including five consecutive years of significant tax
base contraction, high unemployment, and low income levels. However,
unemployment has fallen somewhat over the past year and recent home
price data shows tentative signs of recovery.
ADEQUATE DEBT PROFILE: The district's debt burden is moderate,
identified capital needs are minimal, and the other post- employment
benefits (OPEB) liability is manageable. However, CalSTRS pension costs
likely will rise significantly moving forward and substantial use of
capital appreciation bonds (CABs) slows amortization somewhat.
GOOD MANAGEMENT PRACTICES: The district benefits from a conservative
management team that has consistently and materially outperformed its
budget and cut expenditures early in the downturn. Like all California
schools, the district is required to publish a large amount of
forward-looking financial data multiple times per year.
Modesto City High School District is located in economically stressed
Stanislaus County in the northern San Joaquin Valley. The district
shares a governing board, administration, and a majority of its
financial operations with Modesto City School District, a legally
separate district whose tax base is about a third of the high school
district's. Please see the press release titled 'Fitch Affirms Modesto
City School District, California's GOs at 'AA-'; Outlook Revised to
Stable' dated Jan. 29, 2013 for more information. As is typical for
agriculturally-concentrated economies, economic factors are weak.
Modesto's October 2012 unemployment rate was high at 12%, though down
moderately from the prior year rate of 13.4%. This improvement was due
to a 1.7% employment base expansion over the same period. The district's
tax base has significant exposure to food processors but there is little
tax base concentration among the top 10 payers, which make up just 7.1%
of assessed valuation (AV).
DISTRESSED HOUSING MARKET WEIGHS ON (News - Alert) TAX BASE
The county's housing market is the third worst-performing in the
country, as measured by home price losses from peak to current values.
This distressed performance has severely impacted the district's AV,
which has fallen a substantial cumulative 28.1% from fiscal years
2008-2013. In fiscal years 2012 and 2013 the losses were 8.6% and 4.7%,
respectively. Year-over-year Zillow average home value data is positive,
showing a 12.4% gain to $138,400 in December 2012. If these gains hold,
AV could trend positive beginning in fiscal 2014.
Fitch's concerns about AV losses are mitigated by the state's
Proposition 98 funding formula. This formula mandates a minimum per
pupil level of district funding. To the extent that local tax base
contraction results in lost local property tax revenues, the state is
obligated to replace those revenues up to the minimum funding level.
However, state revenues have been subject to significant deferrals in
recent years that the state has recently begun to pay back.
SOUND FINANCIAL PERFORMANCE TO DATE
The district implemented expenditure reductions sufficiently early in
the economic and funding downturn that it has been able to stabilize and
grow its financial cushion in three of the past four years. Audited
results for fiscal 2012 point to a sizeable $9 million operating surplus
(after transfers) that raise the total and unrestricted general fund
balance to high levels of $72.2 million (30.7% of expenditures and
transfers out) and $71.7 million (30.3%), respectively.
Fiscal 2013 general fund operations are projected to esult in a $13.1
million operating deficit. However, management historically has
well-outperformed its budgetary and 1st interim financial projections.
In fiscal 2012 the district out-performed its 1st interim projections by
nearly $30 million. Management expects the actual fiscal 2013 operating
deficit to range between $1 million and $2 million, which would leave
the district's financial cushion at still-high levels. A majority of the
district's financial out-performance was due to spending well below
projected amounts, particularly with regard to categorical programs.
DISTRICT LIKELY TO OUTPERFORM CONSERVATIVE FINANCIAL PROJECTIONS
The district is projecting substantial operating deficits from fiscal
years 2013-2015 ranging from $11.3 million to $24.2 million, which are
an improvement from prior years' projections. The assumptions include no
revenue growth and the sunsetting of significant labor concessions in
fiscal years 2014 and 2015. As in prior years, Fitch believes that these
projections reflect a large degree of conservatism, and Fitch expects
management will substantially narrow or close its out-year deficits in
order to retain the district's solid financial cushion. If the district
drew down its general fund balance on a consistent basis or more than
moderately, however, Fitch likely would take negative rating action.
STATE REVENUE PRESSURES TENTATIVELY EASING SOMEWHAT
The district has faced several years of challenged state funding levels
as California has dealt with its own financial issues. However, two
recent developments could provide a boost to the district's revenue
position. First, in November 2012 California voters passed Proposition
30, which prevented significant automatic K-12 funding cuts from
occurring in fiscal 2013. Fitch previously cited this issue as a
material risk. Second, the governor's budget proposes a 5% increase of
fiscal 2014 Proposition 98 funding, by far the district's largest
funding source. Actual funding, however, will not be determined until
the state budget is adopted around June.
The district has a moderate amount of remaining legal expenditure
flexibility that could be utilized should the district's funding outlook
deteriorate from current expectations. Options include a limited degree
of class size flexibility, cuts to athletic programs and various
auxiliary positions, and categorical programs that could be eliminated.
As with most districts that have implemented significant cuts in recent
years, political considerations could make it difficult to implement
some or all of these legal options. A history of mixed labor relations
could also hamper expenditure flexibility, although recent negotiations
reportedly have been quite amicable. Nonetheless, Fitch views favorably
the existence and identification by management of potential and
significant expenditure reductions.
SOUND MANAGEMENT PRACTICES, TYPICAL AB1200 REPORTING PROCEDURES
The district has adhered to sound management practices, including the
use of very conservative budgeting, ongoing maintenance of a solid fund
balance, and years of expenditure reductions to mitigate the weak
The district also is subject to AB1200 financial reporting procedures,
as are all California districts. These procedures require the district
to perform multi-year financial forecasting multiple times per year and
to comment on over 30 potential financial red flags. The district's
budgets and two interim reports must be reviewed and certified
internally and also by the county office of education. Qualified or
Negative certifications may lead to various levels of external financial
intervention. Fitch views these statewide school procedures as strong.
DEBT PROFILE WEIGHED BY CALSTRS CONCERNS & CABS' IMPACT ON AMORTIZATION
The district's debt profile is adequate overall. Net debt levels are
moderate at $1,672 per capita (2.9% of AV), principal amortization is
moderate, and identified capital needs are minimal. The district has no
plans to issue further debt and its OPEB liability is manageable.
However, these strengths are moderately offset by two factors. First,
the district participates in the poorly funded CalSTRS pension system,
as do all schools in the state. Although the district is paying 100% of
its required rate, in fiscal 2011 system contributions were equal to
just 46.7% of the actuarially required rate.
Second, all of the district's GO debt consists of non-callable CABs,
which slows principal amortization somewhat. This credit weakness is
somewhat mitigated by the CABs' serial maturation each year through
final maturity in fiscal 2027. Also, principal amortization is only
modestly below average, at 45% in 10 years (as calculated using final
The district's current GO authorization tax rate is currently $38.16 per
$100,000 AV, which exceeds the district's estimated maximum tax rate of
$30 at the time the bonds were authorized by voters in 2001. This
weakness is mitigated by the low nominal tax bill associated with GO
debt service, apparent lack of political or taxpayer backlash as a
result of the tax rate, and no intent from the district to seek an
additional GO authorization.
CalSTRS' contribution rates are set by statute, and they have not been
increased to reflect the weak investment return environment over the
past several years. As a result, the system's Fitch-adjusted funded
ratio has fallen to a low 65.7% and future contribution rates likely
will need to rise substantially from current levels. It is unclear which
stakeholders would face increased contribution rates, and how such
increases would be implemented, but Fitch believes districts would be
likely to bear at least part of the burden.
Additional information is available at 'www.fitchratings.com'.
The ratings above were solicited by, or on behalf of, the issuer, and
therefore, Fitch has been compensated for the provision of the ratings.
In addition to the sources of information identified in Fitch's
Tax-Supported Rating Criteria, this action was additionally informed by
information from Creditscope 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
U.S. Local Government Tax-Supported Rating Criteria
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