OREANDA-NEWS. Fitch Ratings has upgraded the following Hamilton City School District, OH ratings to 'AA' from 'AA-':

--Issuer Default Rating (IDR);

--$72.3 million unlimited tax general obligation (GO) school improvement refunding bonds, series 2015.

The Rating Outlook is Stable.

SECURITY

The bonds are payable from an ad valorem tax on all taxable property within the district's boundaries without limitation as to rate or amount.

KEY RATING DRIVERS

The upgrade to 'AA' from 'AA-' reflects implementation of Fitch's revised criteria for U. S. state and local governments, which was released on April 18, 2016. Under the new criteria, Fitch regards the district's operating performance as more robust than previously in terms of reserve adequacy levels versus likely revenue volatility. Fitch believes that the district would retain significant financial flexibility during a downturn given a strong ability to reduce staff and pay for facilities upkeep with funds held outside of the general fund that are generated by tax millage earmarked for capital. The 'AA' rating also reflects the district's moderate long-term liability burden and solid revenue growth prospects linked to a state education funding environment favoring districts with enrollment profiles similar to Hamilton City's.

Economic Resource Base

Hamilton City School District is located in Butler County in southwest Ohio, 25 miles north of Cincinnati and 30 miles southwest of Dayton. Enrollment for 2015-16 totaled 9,735, representing an 8.8% rise in student enrollments since the 2005-06 academic year. Wealth levels are below Ohio and U. S. medians, but the unemployment rate has come down significantly since 2013 and the work force is growing.

Revenue Framework: 'a' factor assessment

Revenues are likely to increase at above the rate of inflation as the district is heavily dependent on state transfers and enrollment is growing. State foundation aid is projected to show strong growth for the next two to four years. The district's independent ability to raise property tax revenues is heavily constrained by Ohio state statute.

Expenditure Framework: 'aa' factor assessment

The district maintains solid expenditure flexibility. It has demonstrated the ability to implement across-the-board cost reductions by negotiating salary freezes with its bargaining units, laying off staff, and making moderate cuts to athletic and academic programs. Carrying costs are slightly below 15% of governmental fund expenditures, and an additional 2% of spending relates to mandatory charter school pass-through expenses, which have been stable. The natural pace of spending growth is likely to be generally in line with, or slightly above, revenue growth in the absence of actions by management.

Long-Term Liability Burden: 'aa' factor assessment

The overall debt burden plus unfunded pension liabilities are moderate in relation to residents' combined personal income. The board of education has no current plans to issue any new money debt.

Operating Performance: 'aa' factor assessment

Financial operating performance is very strong. The district has achieved five operating surpluses over the last seven fiscal years and estimates an additional surplus for fiscal 2016 (June 30 year-end). Fitch expects the district's financial resilience in a downturn would be very strong, given the district's solid control over expenditures, healthy reserve levels and expected moderate revenue volatility.

RATING SENSITIVITIES

Reduced State Aid: The rating is sensitive to deep and sustained reductions in state education assistance transfers from the State of Ohio ( 'AA+'/Outlook Stable) and the impact such reductions could have on the district's reserves and liquidity.

Conservative Management: The rating is also sensitive to the abandonment of historically conservative budget management policies; were such an abandonment to occur, it might endanger the district's solid financial performance.

CREDIT PROFILE

The school district is largely coterminous with Hamilton City, OH, and includes portions of neighboring Hanover Township. Hamilton is a city of about 63,000 residents in southwestern Ohio near the Kentucky-Ohio border. Hamilton's population and economy have shown stability since the late 1990s, although wealth levels are below U. S. and state averages (i. e. about 75% of the state average) and the unemployment rate has historically been slightly higher than Ohio's.

Population has grown by 3.4% since bottoming out in 2000 at 60,690, and remains only 13% below its historic peak in 1960, in contrast to many other former Midwestern manufacturing centers. Butler County's economy and population are growing (up by 12% from 2000 to 2010) and the region offers a wide variety of employment opportunities for Hamilton City residents. The largest employers include Fort Hamilton Hospital (1,020), Community First Solutions (healthcare) and Miami University.

The housing market continues to be affected by the after-effects of the prior decade's property market downturn. The district's AV is nearly 20% below is 2010 levels as a result of a drop in residential values and increased foreclosure levels during the recession. The contraction in assessed values has not impacted district financials because, in Ohio, AV declines are automatically offset by increases in the effective tax rate to prevent districts from losing tax revenue where continuous levies are concerned. Enrollments have grown consistently since 2005 despite the presence of a local charter school and the fact that several neighboring districts allow open enrollments, which allow students from other home districts to transfer into those districts. Fitch views the district's ability to grow enrollments in such an environment as a factor in its favor, as it directly benefits from the trend by reaping larger amounts of state foundation aid.

Revenue Framework

Hamilton City School District is highly state aid dependent (i. e. roughly 78% of recurring revenues originate from the State of Ohio), reflecting the district's lower wealth levels. Near-term revenue growth prospects are relatively strong given that the district has benefited from a 2011 revision of the state aid formula that favors poorer districts with growing enrollment. The district's independent legal ability to raise revenues, however, is highly restricted by Ohio state statutes. Local taxes accounted for 20% of general fund revenues in fiscal 2015.

The district's tax levies mostly consist of continuous levies approved by voters in prior years to support operations and debt retirement. The exceptions include 1.27 mills of unvoted 'inside' millage supporting the general fund and 3 mills of inside millage supporting the permanent improvement fund. The 1.27 inside mills supporting the general fund accounted for a minuscule 0.6% of general fund revenues in fiscal 2015.

The continuous, voted levies consist of 39.54 mills supporting general fund operations, 9.11 mills that generate revenue to fund the bond retirement account, and 0.5 mills that fund permanent improvements alongside the 3 transferred inside mills. All levies are fixed rate, rather than fixed dollar, and can therefore capture tax base growth generated by new construction but not AV increases due to property value appreciation.

The district has benefited greatly from a statewide overhaul in the school funding formula implemented in 2011. Rising student enrollments and recent drops in AV have also benefited the district under the revised funding formula. Year-over-year growth in total foundation aid revenue is limited by a statewide 7.5% cap on annual growth. The district conservatively projects 2% growth in state aid in fiscal years 2018 through 2020, but it is possible that growth could be above 2%, in keeping with recent history.

The district's 2004-2014 10-year revenue compound annual growth rate (CAGR) was 3%. This is above the rate of inflation, but below the rate of U. S. GDP growth during that period. The CAGR does not take into account any actions by management to raise revenues during that period, as no new levies were approved and natural growth in the property tax levy was minimal. Growth instead mainly reflects expansion of state foundation aid transfers to the district.

The district's independent legal ability to raise local revenues is essentially nil, as it would need voter approval to raise new operating tax revenues. It has not asked voters to approve a new levy since 1993. All of the district's existing voted levies are permanent, so there is no associated renewal risk.

Expenditure Framework

The district provides a full range of K-12 academic and athletic programs for its students, including various types of special education and academic enrichment programs. Expenditures have grown more slowly than revenues during the past four years due principally to the 2011 revision of the foundation aid formula. While the majority of its services are mandated by law, the district has some flexibility around program choice and design, as well as a high degree of control over staffing levels. Carrying costs are moderate, being below 20% of governmental fund expenditures.

The natural pace of spending growth would, in all likelihood, have been closely in line with revenues over the past five years absent management actions to limit expenditure growth during and after the recession. Between fiscal 2009 and fiscal 2011, management pro-actively cut staffing levels and initiated moderate program cuts to cope with a more challenging revenue environment. The district secured a three-year wage freeze from its bargaining units in fiscal 2011 that lasted through fiscal 2014. Revenues have outpaced expenditure growth since 2014, which district management forecasts will continue through fiscal 2018. Over the longer term, Fitch expects expenditure growth to track more closely to revenues, particularly give five-year contracts with the bargaining units that extend to June 2020. Under the contracts, employees received wage increases of 3.5% in fiscal 2016, and will receive salary increases of 5% in fiscal 2017 and 3% in fiscals 2018 through 2020.

Management has a successful track record of curbing expenditure growth. Although contracts with the four bargaining units extend to fiscal 2020 and do not contain re-openers, management retains full control over staffing levels. If circumstances required, management believes it could achieve significant cost savings by reducing staff and programs restored since fiscal 2014 due to the more generous foundation aid distributions. The district also has considerable flexibility to decrease maintenance spending given the recent vintage of most school buildings. Capital spending is handled primarily out of the permanent improvement fund, which held $4 million in reserves at fiscal 2015 year-end.

Carrying costs including debt service, annual pension contributions and payments for other post-employment benefits (OPEB) have accounted for between 13% and 15% of governmental fund spending since 2012. Debt service, which accounts for the majority of fixed costs, is level through 2024, so this metric is likely to improve in the absence of new debt issuance. When $3.8 million of annual charter school pass-through expenses are factored in, fixed costs rise to a still moderate estimated 17% for fiscal 2016. The district is home to a single charter school and some students residing in the district follow an online learning program through 'cyber-charter' schools. Management plans to open its own digital academy within the next year to bring some of these enrollments back into the district.

Long-Term Liability Burden

The district's long-term liability burden is moderate compared to its personal income level. Long-term debt, including the debt of overlapping jurisdictions, plus unfunded pension liabilities, equaled 12% of personal income in fiscal 2015. The district had $81.5 million of direct debt outstanding at 2015 fiscal year-end. No additional new money issuance is planned. As a result, this metric could conceivably decline over time given that net total debt represents a negligible portion of the total liability burden (4.8% of personal income versus 7.5% for pensions) and the majority of it consists of the school district's direct debt, half of which will be retired within 10 years.

Alternatively, the long-term liability burden could rise if the district's proportionate share of the liability associated with two state-sponsored defined benefit pension plans, the Ohio School Employees Retirement System (OSERS) and the Ohio State Teachers Retirement System (OSTRS), rises due to either investment losses or underfunding of required contributions. The plans reported a combined ratio of assets to liabilities of 74.2%, assuming a 7.75% rate of return, as of Dec. 31, 2014. Using Fitch's more conservative 7% rate of return assumption for the plan's assets, Fitch estimates a slightly lower ratio of assets to liabilities for the two plans of 68.5% as of the same date.

Operating Performance

Fitch believes the district's ability to withstand an economic downturn while maintaining financial resiliency in the form of inherent budgetary control and adequate fund balances to be very strong. While the district's ability to raise new tax revenues is almost non-existent, Fitch views its solid level of expenditure flexibility as a positive. Additionally, the district's currently healthy reserve position will serve as a strong shock-absorber against a moderate economic downturn. General fund balances totaled $17.4 million in fiscal 2015, equal to 21% of spending. An estimated operating surplus for fiscal 2016 would raise available reserves to over $20 million, or about 26% of spending. Projected growth in reserves through fiscal 2019, if realized, would fortify the district to withstand a severe downturn using reserves alone. Our analysis considers a milder scenario, however, balanced by cost reductions that are well within the district's power. Fitch expects reserves would remain above the 'aa' assessment level.

Management has demonstrated cautious budgetary controls through economic cycles and the ups and downs of state aid funding alterations. The administration prudently decided to take advantage of the upswing in foundation aid post-2011 by restoring general fund reserves, which bolster the district's ability to withstand future economic declines. Previously, general fund reserves had been drawn down to negative balances in fiscal 2009 due to recession-driven state spending cuts. Fitch does not expect this pattern to be repeated. The district's May 2016 five-year forecast includes a commitment to further reserve augmentation; management estimates general fund reserves climbing to $28.5 million, or 29% of spending by fiscal 2018, with the strongest growth coming in fiscal 2016 and 2017. Fitch views this forecast as reasonable given that expenditure projections have been revised upward since last October, and revenue increases projected for fiscal 2017 are in line with state guidance.

The district possesses additional fiscal reserves outside of the general fund, in its debt service and permanent improvement funds. The permanent improvement fund held $4.1 million at fiscal year-end 2015. There are limitations on what expenditures may be covered by permanent improvement fund balances; however, the district has been able to use these moneys to purchase textbooks and school buses, as well as pay for routine maintenance of facilities. If a recession were to occur and state aid revenues declined, the district could rely on a portion of those funds to cushion the revenue impact on other areas of the budget, as a temporary gap-closing measure. Altogether, the district had $35 million of cash balances available at fiscal 2015 year-end versus $130 million of operating fund expenditures - a substantial liquidity cushion in the event of unforeseen costs.