[April 26, 2016]

Fitch Rates $38MM Temecula Valley USD, CA's GOs 'AA-'; Outlook Stable

Fitch Ratings has assigned a 'AA-' rating to the following Temecula Valley Unified School District, California's:

--$37.5 million general obligation bonds, 2012 election, series 2016-B.

The bonds will sell via negotiated sale the week of May 2nd. Proceeds will be used to finance and make improvements to eligible public schools facilities.

Fitch also has affirmed the district's 'AA-' Issuer Default Rating (IDR) and the 'AA-' rating on:

--$34.8 million general obligation bonds, 2012 election, series 2013-A.

The Rating Outlook is Stable

SECURITY
The GO bonds are secured by an unlimited property tax on all taxable property within the district.

KEY RATING DRIVERS

The 'AA-' rating is based on solid long-term revenue growth prospects pursuant to the state's guaranteed funding formula, the district's solid expenditure flexibility enabled by good labor relations, management's willingness and ability to make spending cuts as necessary to maintain a targeted 10% average financial cushion, and the district's moderate long-term liability burden relative to its resource base.

The district's local economy, located mainly in the city of Temecula, benefits from high wealth levels, low unemployment, and ready access to three large and diverse employment markets. The city is largely a wealthy bedroom community, located within commuting distance to the large and diverse employment markets of Los Angeles, Orange (News - Alert) County and San Diego. Tourism is also a major draw, with a large Native American casino and a significant wine producing industry; the construction of a new regional hospital will contribute to greater diversification. The district's population has remained steady although school enrollment has been experiencing slight decreases.

Revenue Framework: 'a' factor assessment
The district has very limited discretion over revenues as it is dependent on the California State Local Control Funding Formula (LCFF) for 80% of its revenues and has no independent legal ability to raise revenues. However, revenues have grown steadily in recent years due to the state's economic improvement and the district's relatively stable enrollment, a trend Fitch expects to continue.

Expenditure Framework: 'aa' factor assessment
The district demonstrates relatively strong flexibility to adjusting spending to match revenues throughout the economic cycle. This is in part due to its low carrying costs, including virtually no OPEB benefits. Spending pressure is expected to be in line with to slightly above revenue growth, incorporating expectations for increased pension funding demand.

Long-Term Liability Burden: 'aa' factor assessment
The district participates in two adequately funded state-run pension plans and funds the bulk of its capital needs from voter approved property tax levies. The resulting long-term liability is moderate relative to the district's resource base and is expected to remain at moderate levels.

Operating Performance: 'a' factor assessment
The district has drawn down reserves in the last couple of years but continues to well exceed its 6% policy for unreserved fund balance. Fitch expects the district to utilize its expenditure flexibility, including its demonstrated ability to negotiate labor concessions, to support financial stability during periods of revenue uncertainty or decline. The district budgets conservatively, building in slight declines in average daily attendance (ADA) and potential increases in labor costs.

RATING SENSITIVITIES
The 'AA-' rating could come under downward pressure if the district fails to maintain fund balances at or above current levels during an economic expansion.

ADEQUATE FINANCIAL CUSHION: The 'AA-' rating and Stable Outlook assume management action to maintain fund balance throughout the economic cycle at levels consistent with Fitch's current evaluation of the district's financial resilience. Failure to do so could negatively affect the operating performance assessment and the overall rating.

CREDIT PROFILE
The district operates 32 schools and serves a total population of about 159,000 in the city of Temecula surrounding cities, and unincorporated communities in southwestern Riverside County.

Revenue Framework
The district is highly dependent on the State of California for the majority of its revenues. The state constitution's priority for education funding and its minimum funding levels based on the state's own revenue performance provide a sound revenue framework, albeit a sometimes volatile one, despite the district having no independent ability to raise revenues. California's proposition 13 requires a vote of the people to raise taxes.

State funding and local property taxes provide the majority of district revenues, which are ultimately determined by a formula based on ADA and overall state revenues. Although the district has experienced a consistent increase in revenues in FY 2015 and 2016, enrollment continues in a slight downward trend.

Historical revenue growth has exceeded both inflation and U.S. economic performance. Future revenue performance will be based on growth trends in local property taxes and state per pupil funding levels may peak over the medium term. As the state's economy continues to experience growth, the district in-turn is expected to receive increased revenue through the local control funding formula (LCFF). LCFF is to be fully funded by fiscal year 2020-21. In each year until then the state will provide a funding percentage or 'gap funding' that will move the district closer to 100% of the new funding model. The district has only received 51% of it due gap funding to date.

Expenditure Framework
Personnel costs for teachers and staff drive the district's expenditures, and the natural pace of growth in these areas is likely to be in line with or moderately above expected revenue growth based on the district's current spending profile.

The district counts on a solid ability to make cuts in personnel costs via labor concessions or changes to headcount. Fixed costs for debt service and retiree benefits are a low burden on revenues. The teacher's pension contribution rates are scheduled to rise but remain manageable. OPEB is not a material consideration as only five employees qualify.

Long-Term Liability Burden
Debt and pension liabilities are a moderate burden on the resource base (currently about 15% of personal income). Direct debt consists of current Interest bonds, capital appreciation bonds (CABs) and Convertible CABS. The district has no capital lease or variable rate debt obligations (VRDO) liabilities. Fitch expects the combined liability burden to remain moderate despite the district's exposure to CalSTRS and slow amortization of existing and new debt with only 30% of principal retired within the next 10 years.

Operating Performance
Fitch expects the district to maintain relatively stable, balanced operations over the long term and available fund balances near 10%, well above the policy level of 6% of expenditures. The district managed to maintain relatively stable fund balances through the recession due to its flexibility and willingness to make expenditure reductions.

Fitch's scenario analysis tool indicates that in an unaddressed moderate economic downturn the district's reserves would drop quickly. However, the district has faced comparable stress scenarios in the past, which it absorbed by aggressively cutting expenditures relative to revenue declines and funding deferrals. Fitch expects that the district will take such responsive offsetting action in future downturns.

Management practices overall have been prudent in addressing revenue contraction in past years. The district's operational deficits in recent years have been manageable and somewhat offset by the current and projected rise in revenues. The district's calculated decision to draw down on fund balances does not compromise the 8%-10% reserves level the district has consistently targeted.

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.

Applicable Criteria
U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=879478

Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1003356
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1003356
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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