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Fitch Downgrades Berea City School District, Ohio's Debt; Outlook Remains Negative
[October 22, 2014]

Fitch Downgrades Berea City School District, Ohio's Debt; Outlook Remains Negative


NEW YORK --(Business Wire)--

Fitch Ratings has downgraded the following ratings for the Berea City School District, OH (the district):

--$3.5 million unlimited tax general obligation (ULTGO) bonds to 'A+' from 'AA-';

--$4.4 limited tax general obligation (LTGO) bonds to 'A' from 'A+';

--$1.3 million special obligation tax anticipation notes (TANs) to 'A+' from 'AA-'.

The Rating Outlook remains Negative.

SECURITY

The ULTGO bonds are secured by an ad valorem tax levied on all taxable property within the district, without limitation as to rate or amount.

The LTGO bonds are non-voted general obligation debt of the district secured by an ad valorem tax levy within the 10-mill limitation.

The special obligation TANs are secured by proceeds from a 1.0 mill permanent improvement levy. Debt service payments on the TANs are legally required to be less than one-half of the levy's annual proceeds ensuring coverage of at least 2x annual debt service. Coverage was 3.7x in fiscal 2013.

KEY RATING DRIVERS

DOWNGRADE ACTION: The downgrade to 'A+' from 'AA-' on the ULTGOs and TANs reflects decreased financial flexibility as measured by a material decline in general fund reserves and liquidity. The one-notch rating distinction between the ULTGOs and the LTGOs is reflective of the district's reduced financial flexibility.

CONTINUED DECLINES IN RESERVES: The maintenance of the Negative Outlook reflects Fitch's concerns that reversing the impact on four consecutive years of general fund deficits will be challenging. Reserves fell to a very low 2% of spending in fiscal 2013.

MATURE ECONOMY; DECLINING ENROLLMENT: Enrollment continues to decline despite the stability of the local economy and tax base. The district is in a mostly mature, suburban community with median household income above the state average and on par with the national average.

MIXED VOTER SUPPORT FOR TAX LEVIES: The district benefits relative to many Ohio districts from permanent tax levies (not subject to voter renewal), however, new tax levies are likely to be needed to bolster reserves but have historically not passed on the first ballot.

MANAGEABLE LONG-TERM LIABILITIES: The district's debt burden should remain low-to-moderate given a lack of future debt plans, average direct debt amortization, and manageable pension and other post-employment benefits (OPEB) costs.

RATING SENSITIVITIES

SUCCESS OF OUT-YEAR BALANCE PLAN: Demonstrated improvement in financial stability and reserves may result in an Outlook revision to Stable. Conversely, continued structural imbalance and reserve drawdowns would likely result in negative rating action.

CREDIT PROFILE

The district, located in suburban Cuyahoga County (LTGO bonds rated 'AA+'; Stable Outlook) southwest of Cleveland, serves the cities of Berea, Middleburg Heights, and Brook Park.

District enrollment has been declining over the last several years and currently totals approximately 6,980, a decrease of 2% over the prior year, and a 5.4% decline since 2008. Competition from charter schools have contributed to the enrollment decline and Fitch expects this trend to continue at least over the medium term.

In order to be more cost effective, the district recently completed a school consolidation program which included combining three elementary schools into one and closing one middle school, which generated total savings of about $4 million realized in fiscals 2013 and 2014. In addition, projected salary reduction savings as a result of the consolidation of $1.9 million and $332,903 are included in fiscals 2015 and 2016, respectively.

SIGNIFICANT REDUCTION IN FINANCIAL FLEXIBILITY

The district's financial operations and fund balances, which had previously been viewed as credit strength, have deteriorated significantly since fiscal 2009. This is largely due to the impact on operating revenue of the phase-out of the tangible personal property tax and the steep decline in property values during and following the recession. Large operating deficits after transfers were recorded in the last four fiscal years. As a result, the district's unreserved or unrestricted fund balance dropped from 17.5% in fiscal 2011 to a very weak 1.6% ($1.4 million) in fiscal 2013.

FIVE-YEAR FORECAST POINTS TOWARD STABILIZATIO



On an unaudited cash basis, the district recorded an $86,443 surplus and an ending cash balance of $2.3 million, or 2.9% of expenditures for fiscal 2014. This compares to an $8.1 million deficit and ending cash balance of $2.2 million or 2.6% of expenditures in fiscal 2013.

The district's October 2014 five-year (2015-2019) cash-basis forecast projects balanced operations through fiscal 2017. The district is projecting a notable improvement in financial operations in fiscal 2015, resulting in a $4.3 million surplus, which improves the ending cash balance to $6.6 million or 8.3% of spending.


Projected growth in fiscal 2015 is primarily driven by an increase in property tax revenue ($1.3 million) and state aid. The new funding formula positively impacted the district, and, combined with two payments of catastrophic special education reimbursements, increased total state aid by approximately $1.7 million over the prior year. State aid comprises about 28% of general fund revenue.

Property tax revenue, which comprises 67% of total general fund revenue, is projected to decline slightly in fiscal 2016 and remain relatively flat for the remaining forecast period. Fitch views the projections as conservative given management's practice of exceeding budgetary expectations.

Fitch notes that the October 2014 five-year forecast does not include revenue from any new tax levies, although a new revenue source will likely be necessary in the longer term to provide additional financial stability.

CONTINUOUS PROPERTY TAX LEVIES; WEAK SUPPORT FOR NEW LEVIES

Fitch believes the continuous nature of the district's current property tax levies relieves some of the uncertainty about voter support that other districts in Ohio face. However, given the inability to capture any tax base growth in continuous levies, Fitch believes the district will be dependent on voter support to increase reserve levels and provide greater financial flexibility.

Management is putting a new 3.9 mill levy on the November 2014 ballot. If passed, the levy will generate approximately $4.7 million annually in revenue. However, common to Ohio school districts, new tax levies have historically not passed on the first try. After failing in November 2011, voters approved (by 55%) a new 3.9 mill levy in March 2012.

STABLE, MATURE ECONOMY

The district is mostly residential with a fairly stable and mature economy. NASA and Ford Motor Company (News - Alert) (Issuer Default Rating of 'BBB-'; Outlook Positive) are the fourth and fifth largest district employers, respectively. Ford recently expanded operations in Brook Park with the completion of its Engine Plant No. 1 retrofit and the commencement of production of its EcoBoost engines.

There is no unemployment data available for the district. As of July 2014, the county's unemployment rate was 7.6%, higher than both the state (6%) and national (6.5%) averages. County employment and labor force growth are flat with the prior year.

TAX BASE PRESSURE TO PERSIST

The tax base has contracted over the last few years with 2014 assessed value (AV) totaling $1.3 billion, flat with the prior year and a 15% decline since 2008. Management projects AV will decline by 7% in the 2015 triennial county update. The tax base is diverse with the top 10 taxpayers comprising approximately 10.4% of AV. Total property tax collections are good, at 97% in fiscal 2014.

MANAGEABLE LONG-TERM LIABILITIES

Overall debt is low-to-moderate at $2,005 per capita and 2.8% of market value. Amortization is average at 52% of principal retired in 10 years. The district has no future debt plans.

The district contributes to the School Employees Retirement System (SERS) and the State Teachers Retirement System (STRS) to fund both pension and OPEB. Both of these plans are cost-sharing, multiple employer defined benefit plans and the district consistently pays its share of statutorily required contributions to both plans. As of June 30, 2013, funding levels for both plans were approximately 61% for STRS and 60% for SERS, based on Fitch's estimated 7% rate of return.

Fitch considers carrying costs to be fairly low with debt service, pension and OPEB claiming 11% of governmental funds spending. The moderate cost is due in part to STRS' underfunding of its actuarially acquired contribution (ARC); the plan funded only 46% of the ARC in fiscal 2013. The SERS plan has been fully funding its ARC. Pension related costs could rise over time if STRS moves towards full funding of its ARC. Contributions to STRS represent 5.3% of the district's fiscal 2013 government fund spending and Fitch believes the district could face additional financial pressure if pension costs were to increase.

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 (News - Alert) Global Insight, and the National Association of Realtors.

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=904874

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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