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TMCNet:  Fitch Affirms San Francisco Community College District's (CA) GOs at 'BBB+'; Outlook Negative

[March 24, 2014]

Fitch Affirms San Francisco Community College District's (CA) GOs at 'BBB+'; Outlook Negative

SAN FRANCISCO --(Business Wire)--

Fitch Ratings has taken the following action on San Francisco Community College District, CA's (News - Alert) (the district) general obligation (GO) bonds:

--$26.8 million 2002 GO bonds (election of 2001, series A) affirmed at 'BBB+'.

The Rating Outlook remains Negative.

SECURITY

The bonds are a general obligation of the district. The board of supervisors of the city and county of San Francisco (the city) is obligated to levy and collect ad valorem taxes upon all property within the district subject to taxation, without limitation as to rate or amount, to pay debt service on the bonds.

KEY RATING DRIVERS

ACCREDITATION CHALLENGES UNRESOLVED: The Negative Outlook reflects uncertainty over the district's future operations following the July 2013 decision to terminate its accreditation by the Western Association of Schools and Colleges' Accrediting Commission for Community and Junior Colleges (ACCJC). The district has appealed this decision and third-party lawsuits may also prove obstacles to its implementation. A lawsuit filed by San Francisco's city attorney resulted in a preliminary injunction against implementation.

SIGNIFICANT MANAGEMENT IMPROVEMENTS: The district has made substantial progress with administrative and financial reforms over the past 18 months in response to deficiencies cited by ACCJC. Further progress will be required to insure the district's long-term success, but reforms achieved to date provide a strong foundation for such efforts.

STATE INVOLVEMENT POSITIVE: Fitch's rating assumes district operations are likely to continue regardless of the ACCJC's pending action. The state has played a key role in supporting district reforms, and Fitch expects state involvement to increase if the district's accreditation is withdrawn.

POTENTIAL 2015 FUNDING LOSS: The district faces a substantial reduction in state revenue for fiscal 2015 due to recent enrollment declines. Proposed state legislation would stabilize funding in 2015 and beyond, but the district could face substantial expenditure reductions if enrollment declines are not reversed. The district's contingency plan to balance its budget in the event this legislation is not adopted mitigates some of this funding risk.

STRONG ECONOMY AND TAX BASE: The district is coterminous with the city, and property taxes pledged to its bonds are supported by San Francisco's exceptionally strong economy and resilient tax base. Wealth and income levels remain high, employment growth is robust, and taxable assessed values (TAV) have experienced steady growth.

MIXED LONG TERM LIABILITIES: Overall debt is high on a per capita basis, but Fitch considers it affordable given the district's wealth levels and strong tax base. Carrying costs for debt service and retirement benefits are moderate but likely to rise, particularly due to chronic underfunding of the California State Teachers' Retirement System (CalSTRS).

RATING SENSITIVITIES

OPERATIONAL DISRUPTION: Failure to complete an orderly transition in the event of accreditation loss would leave the district unable to continue as a going concern, and likely result in a multi-notch downgrade.

FINANCIAL DETERIORATION: A material reduction in apportionment revenues, if unmatched by expenditure cuts, would likely require a drawdown in reserves and result in additional downwards rating pressure, irrespective of the district's accreditation status.

CREDIT PROFILE

The district serves approximately 85,000 students across nine campuses. Students are drawn primarily from the city, whose general obligations Fitch rates 'AA' with a Stable Outlook.

ACCREDITATION CHALLENGES UNRESOLVED

The district faces continued operational uncertainty following ACCJC's July 2013 action to terminate its accreditation effective July 31, 2014, an outcome previously considered unlikely by district management. Implementation of this action is subject to appeal, at which point the district may introduce new information for ACCJC's consideration. Such new information would likely include accreditation-related reforms over the past 18 months, which were not formally considered in the July 2013 termination action.

Implementation of any termination action by the ACCJC could be complicated by any one of several active legal and political challenges to its authority. A preliminary injunction against termination of the district's accreditation was granted in San Francisco Superior Court in January 2014, in response to a suit by the city's elected attorney. A trial is not anticipated before fall 2014. Until the suit is resolved, the injunction protects the district against any funding changes resulting from accreditation loss. A second lawsuit by a district labor union has similarly challenged the ACCJC's authority to terminate the district's accreditation. The ACCJC also faces challenge from the U.S. Department of Education, which has questioned the accrediting organization's compliance in several areas related to its sanctioning of the district.

A loss of accreditation would make the district ineligible to receive state apportionment revenues and federal student aid, but it retains several options for continuing operations under this scenario. Management believes the district could maintain non-credit programs in the absence of accreditation, which would preserve approximately 42% of current funding. District operations would be scaled back severely under such a scenario. The district would likely seek re-accreditation for eligible programs, a process that could take two or more years.

The post-accreditation termination operations of the Compton Community College District (Compton CCD) in southern California are a potential model for the district if ACCJC's decision is upheld. Following the loss of its accreditation in 2005, Compton CCD received a loan from the state to support its continued operations and entered into a partnership with a fully accredited neighboring community college. It continues to serve local students and meet debt service obligations on issuances both prior to and following its loss of accreditation. Fitch expects that the district's legal status would be similarly unimpaired by the loss of accreditation.

STATE INVOLVEMENT POSITIVE

State oversight of the district to date has included the appointment of a special trustee in place of its elected board as well as two in-depth management reviews by the state's Fiscal Crisis & Management Assistance Team. In addition, the California Community Colleges Chancellor's Office has sponsored legislation to stabilize funding for the district over the next four years. Fitch believes that the state retains a strong interest in preserving district services and expects state involvement to increase if the district's accreditation is withdrawn.

SIGNIFICANT MANAGEMENT IMPROVEMENTS

The district has made substantial improvements to its operations over the past 18 months despite its continued accreditation challenges. A new management team includes a special trustee appointed by the state chancellor for community colleges. The special trustee serves in place of the district's elected board and has broad authority to implement changes in district operations. In addition, the district has recently hired a new local chancellor and several vice chancellors with extensive experience managing community colleges, including those with accreditation challenges. These and other recent appointments respond directly to ACCJC's prior criticisms of the district's insufficient administrative resources, and support broader efforts to improve its compliance with accreditation standards.

The district has addressed ongoing financial challenges with an eight-year plan for fiscal stability. The plan would increase the district's board-designated reserves to 8% from 2% of expenditures and also commits the district to new investments for deferred maintenance and technology improvements, as well as increased funding for other post-employment benefits (OPEBs). Expenditure controls have been aided by a 5% salary reduction implemented in mid-fiscal 2013, with 1% restored pursuant to new two-year contracts with all major bargaining units.

POTENTIAL 2015 FUNDING LOSS

The district experienced a sharp drop-off in enrollment in fiscal 2012 amidst extensive media coverage of its accreditation challenges. This decline could result in a revenue reduction of up to $18 million in fiscal 2015, equivalent to approximately 10% of unrestricted general fund revenue in 2013. Proposed state legislation to be considered in spring 2014 would delay this reduction (while the district's accreditation challenges continue) and appears to have strong prospects for adoption. The district is also in the process of improving outreach and marketing to restore enrollment levels and is developing expenditure reduction options as part of its fiscal 2015 budget development process.

The potential loss of funding in 2015 stands in contrast to generally improving revenue prospects for the state's community colleges, including the district. Funding levels for fiscal 2013 and beyond have been aided by strengthened state finances as well as temporary state and local tax measures. Proposition 30, approved by California voters in 2012, is expected to raise approximately $6 billion in new revenues annually through fiscal 2017, with smaller revenue gains through fiscal 2019. The new taxes and higher collections from existing taxes contribute to a proposed 8% increase in state funding for community colleges in fiscal 2015. In addition, San Francisco voters approved a temporary parcel tax that will provide an estimated $16 million in annual revenues for the district over the next eight years. The district's financial position remains challenged due to past reductions in state apportionments and a history of short-term decision-making that have diminished reserves, but appears likely to improve if recent progress can be sustained.

STRONG ECONOMY AND TAX BASE

TAV levels rose by 4.5% in fiscal 2014 and maintained a 3.2% compounded annual growth rate over the past five years. Employment growth has been similarly robust and the city's unemployment rate fell to a very low 4.8% in December 2013, well below state and national averages. Wealth and income levels are high.

MIXED LONG TERM LIABILITIES

Overall debt of $6,384 per capita is high, but moderate relative to the size of the city's tax base. Amortization of the district's debt is average, and management has no plans for further borrowing as the district approaches the end of a large debt-funded expansion program, approved by voters in 2001 and 2005.

Carrying costs for debt service and retirement benefits are currently moderate but likely to rise over the medium term to address substantial CalSTRS liabilities, which nearly quadrupled between 2008 and 2013. Such actions would require state legislative approval, and impacts on CalSTRS employers such as the district remain uncertain. Given the large cost of addressing past underfunding, however, Fitch expects that the burden will be shared among participating employers as well as the state.

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 Financial Crisis & Management Assistance Team/California School Information Services and the Accrediting Commission for Community and Junior Colleges/Western Association of Schools and Colleges.

Applicable Criteria and Related Research:

--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 14, 2012).

Applicable Criteria and Related Research:

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=824814

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON (News - Alert) THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.


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