Fitch Affirms Banning USD, CA's GOs at 'A+'; Outlook Revised to Stable

Fitch Ratings has affirmed Banning Unified School District, California's (the district) general obligation bonds (GOs) at 'A+' and revised the Rating Outlook to Stable from Negative on the bonds listed below:

--$47.5 million GOs (election of 2002) series A & B and (election of 2006) series A & B.

SECURITY

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

KEY RATING DRIVERS

IMPROVED FINANCIAL PERFORMANCE: The Outlook revision to Stable reflects significant financial improvement, including material fiscal 2013 general fund out-performance. Sizeable, anticipated local control funding formula (LCFF) revenue gains are expected in the out-years but remain dependent on the state's own financial performance, which has been historically volatile.

WEAK ECONOMY IN RECOVERY: The district's economy is weak as exhibited by low income levels, high unemployment, and a concentrated tax base that contracted rapidly during the housing-led recession. However, recent economic indicators suggest the economy is stabilizing, including the district's first tax base expansion since fiscal 2009, and declining unemployment.

PRESSURED DEBT PROFILE: The district's participation in the weakly funded state teachers' retirement system (CalSTRS) remains a credit concern; debt amortizes quite slowly, and the district has insufficient tax rate capacity to take advantage of its remaining GO authorization. Mitigating these concerns, carrying costs are currently low and the debt burden is moderate.

HIGH MANAGERIAL AND ADMINISTRATIVE TURNOVER: The district's administrative team and board members have turned over at a rapid rate partly due to turbulent financial and local political issues. However, the district's new superintendent and board members have demonstrated prudent financial decisionmaking.

RATING SENSITIVITIES

The rating is sensitive to the district's ability to maintain at least the state-required 3% minimum unrestricted general fund balance; failure to do so would likely lead to a rating downgrade. The rating is also sensitive to continued financial improvement and managerial stability.

CREDIT PROFILE

Located in western Riverside County, 80 miles east of downtown Los Angeles, the district encompasses 300 square miles, including the city of Banning and portions of unincorporated Riverside County, including the Morongo Indian Reservation; the population is estimated at 34,000 residents. The district operates several schools with total average daily attendance of approximately 4,100.

WEAK ECONOMY SHOWING SIGNS OF STABILIZATION

Banning was hard hit by the housing-led recession, exacerbating the already weak economic profile, but has shown recent signs of stabilization. Employment has grown modestly for four years, but the city's total level of employment at 10,530 is still marginally lower than its 2007 pre-recession peak. The July 2013 unemployment rate was a significant drop from one year prior but to a still high 12.8% from 15.2%.

Median household income levels are low at just 61% and 71% of state and national averages, respectively. Poverty rates are higher than average and educational attainment significantly lags the nation.

The district's tax base was severely impacted by declining home values during the recession, contracting by 20% from fiscal years 2010 to 2013. Fiscal 2014 assessed valuation (AV) increased moderately by 2.7%; however, year-to-date property values are up by a substantial 31% through November 2013, according to Zillow.

Rapidly rising property values bode well for fiscal 2015 AV, which will reflect property values as of Jan. 1, 2014. Rising AV will not increase total operating revenues for the district due to the mechanics of the state funding formula but could provide needed tax rate flexibility to issue GOs if the AV gain is sufficiently high.

MATERIALLY IMPROVED FINANCIAL POSITION

The district's financial position has been strained for several years owing to a material loss of state funding without commensurate expenditure reductions. As a result, general fund operations produced sizeable deficits from fiscal years 2010 through 2012, and the county office of education (COE) appointed a fiscal advisor to assist the district in improving its financial position.

In fiscal 2013 the district embarked on a fiscal recovery plan, composed largely of expenditure reductions, and recent state funding has also improved significantly. These developments, in addition to prior year expenditure reductions, have materially improved the district's financial position, and the fiscal advisor assigned by the COE was revoked as a result. The district believes little expenditure flexibility remains, should it be needed, which could constrain future operations. The state's pay-down of deferred funding has improved the district's liquidity position, which has relied heavily on tax revenue anticipation notes (TRANs) in prior years.

The general fund produced an unaudited surplus of $367,000 in fiscal 2013, substantially out-performing earlier projections of a $1.5 million deficit. The out-performance was due largely to special education savings and conservative budgeting. The district recently in-sourced its special education program from the county, thus saving approximately $1 million annually. The district is considering other programs currently operated by the county that could be in-sourced for ongoing savings.

The district is budgeting for a $581,900 operating deficit in fiscal 2014. However, the budget conservatively assumes that it will receive only $900,000 in LCFF revenues, instead of the $2 million it currently expects to receive. These revenues are expected to grow by approximately $2.5 million annually through fiscal 2016, and this growth is not reflected in the district's conservative multi-year financial projections. The district's state funding growth is significantly higher than most districts in the state because of its high population of targeted students (about 88%) who receive additional state funding resources.

FINANCIAL VULNERABILITIES REMAIN

The district continues to face financial vulnerabilities in spite of its much improved financial position. Rising LCFF funding moving forward is dependent on state revenue growth, which historically has been volatile and difficult to predict, leading to fluctuations in district resources. To the extent that funding growth materializes, the district is expected to be pressured to restore services, wages, and deferred maintenance that were cut during the recession. Lastly, the district could face materially higher pension costs moving forward, as described in the debt section below.

A PRESSURED DEBT PROFILE

The district's debt amortizes quite slowly, with just 7% and 21% of principal repaid over five and 10 years, respectively. Deferred capital needs are significant and the district has some remaining capacity from its GO authorization; however, there is insufficient current tax rate capacity to issue additional GO bonds.

The district participates in the weakly funded CalSTRS, as do all school districts in the state. CalSTRS' 2012 funded level was just 67% and falls to 63.5% when Fitch adjusts the system's 7.5% discount rate to a standardized 7%. CalSTRS contribution rates are set by the legislature and have not been increased in recent years to address significant investment losses. Fitch expects the legislature to begin increasing contribution rates, perhaps substantially, over the coming years to improve funding of the system.

These weaknesses are somewhat mitigated by the district's moderate debt burden of $3,058 per capita, or 4.4% of AV. Carrying costs (OPEB, pension, and debt service over total governmental expenditures) are low at 12%. However, Fitch expects carrying costs to rise if and when pension contribution rates are adjusted upwards.

HIGH MANAGEMENT TURNOVER, BUT RECENT PRUDENT ACTIONS

The district's management and administrative profile is weighted by much higher than average turnover among key decisionmakers and administrators. The district's weak financial profile necessitated politically unpopular cost-cutting decisions that culminated in political discord and numerous resignations throughout the district's management team. Fitch views this instability as a negative, but views positively actions taken by the new superintendent and board members that have helped stabilize the district's financial position.

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.

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=813812

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