OREANDA-NEWS. Fitch Ratings has affirmed the following Cleveland Municipal School District, OH ratings:

--Issuer Default Rating (IDR) at 'A-';

--$55 million Unlimited Tax GO School Improvement Bonds, Series 2010 at 'A-';

--$17.5 million Unlimited Tax GO School Improvement Refunding Bonds, Series 2012 at 'A-';

--$27 million Unlimited Tax GO School Improvement Refunding Bonds, Series 2013 at 'A-';

--$151 million Unlimited Tax GO School Improvement Bonds, Series 2015A at 'A-';

--$49 million Unlimited Tax GO School Improvement Bonds, Series 2015B at 'A-'.

The Rating Outlook is Stable.

SECURITY

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

KEY RATING DRIVERS

Affirmation of the 'A-' rating is supported by the district's satisfactory expenditure controls, moderate long-term liability burden, and high level of political support from the State of Ohio for actions taken by management to realign staff and facilities with a smaller student body and to revamp curriculum.

Economic Resource Base

The district serves Cleveland, the second-largest city in the State of Ohio and one of its principal economic centers. Cleveland's economy has become more diversified and less dependent on manufacturing in recent years; the healthcare and higher education sectors are the city's largest employers and provide Cleveland with a measure of economic and employment stability. Cleveland continues to exhibit above-average unemployment and high poverty levels; enrollment declined notably between 2006 and 2014, falling to 38,000 from 57,000 (-33%), before rising by roughly 400 in 2015.

Revenue Framework: 'bbb' factor assessment

The 10-year rate of revenue growth through 2014 was roughly in line with CPI, but would have been lower absent a 2012 tax increase approved by voters. Ohio school districts generally have weak independent legal authority to raise revenues. They must appeal directly to local voters to enact increases to recurring property tax revenues.

Expenditure Framework: 'a' factor assessment

Expenditure growth would have outstripped revenue growth absent the 2012 tax increase and action taken by management to control costs. Ohio is a strong labor state, but the state in 2012 provided the district with a unique set of tools (i. e. the 'Cleveland Plan') to assist it in managing program costs and rewarding classroom achievement, including the introduction of a new, performance-based compensation system. Carrying costs are low at 7.6% of fiscal 2015 governmental expenditures.

Long-Term Liability Burden: 'aa' factor assessment

The district has a moderate long-term liability burden, amounting to about 14% of the district's combined personal income. The bulk of the liability burden is associated with pensions. Amortization of direct debt is slow with final maturity in 2049.

Operating Performance: 'bbb' factor assessment

The district's financial resilience is relatively weak. Fitch believes a near-term, moderate economic downturn could decimate the district's fund balance in the absence of determined policy actions. By contrast, management's efforts to promote fiscal stability and rebuild reserves during the recent recovery have achieved a measure of success; the district has been willing to enact deep cuts and successfully campaigned for a tax levy increase to help stabilize finances.

RATING SENSITIVITIES

RESERVE MAINTENANCE: The rating is sensitive to declines in fund balances and liquidity that constrain the district's already-limited financial flexibility.

STATE AID REDUCTIONS: Reductions in the district's share of state education aid could be a precursor to declines in reserves and could result in a downgrade.

LEVY RENEWAL RISK: Failure by voters to re-approve the district's renewal levy in the Nov. 2016 election could also pressure the rating, although the district's ability to schedule successive elections at six-month intervals ensures the issue can be taken up again with voters. A failure to re-approve would negatively impact the district's revenue framework assessment; it would also result in the likely depletion of the district's reserve cushion by mid-fiscal 2018.

CREDIT PROFILE

The district's boundaries overlap almost exactly with those of the city and it primarily serves the school-age population of Cleveland. The proportion of Cleveland's 388,072 residents living in poverty is elevated, at over 35%, and per capita income levels are less than 70% of the state average. Cleveland's tax base is undergoing some notable changes. The city has witnessed significant growth in new hotels related to the Republican National Convention in July 2016. Aside from growth in the hospitality industry, Cleveland's sizable health care sector has pursued a variety of projects totaling over $1 billion to expand hospitals, cancer clinics and medical office towers.

Recovery in assessed values (AV) has been slow since 2009, however, and the tax base has just absorbed another hit from the removal of The Cleveland Clinic and The Global Center for Health Innovation from the county, city and district tax rolls due to the resolution of a longstanding legal dispute. The district's 2016 AV was revised downward to $4.65 billion from $5 billion as a result. Management anticipates that the revision will result in a minor loss of tax revenues, but could result in increased aid under future state budgets, as AV declines have made the district poorer under Ohio's foundation aid formula.

Revenue Framework

The district operates within a restrictive revenue framework. On average, the district receives between 65% and 69% of its funding from the state in any given year, with the lion's share of the remainder coming from local property tax revenues that require voter approval.

Local revenues would have been essentially stagnant absent the voter-approved passage of 15 new, renewable mills in 2012 that accounted for 6.6% of revenues in fiscal 2015. The district's other tax rates are set as follows: a 4-mills unvoted operating levy subject to Ohio's 10-mill limitation, a 54.2-mills continuous operating levy, 5.2 continuous mills for debt retirement, and 0.5 mills levied continuously for permanent improvements. Aside from the millage levied to pay debt service on voter-approved bond issues, all levies are fixed rate, meaning that they can capture revenues generated by new construction but not appreciation in values, and are vulnerable to declines in AV linked to economic downturns.

Revenue growth was in line with the rate of inflation from 2004 to 2014, although overall performance was enhanced by the 2012 property tax rate increase. Aside from local voter support, natural revenue growth was fairly weak over this period. A steady drop in enrollments since 2005 linked to the district's open enrollment policy and an expanding charter school presence has restricted state foundation aid growth, as foundation aid is closely linked to enrollment patterns. Foundation aid is likely to undergo a modest near-term expansion, however, due to Ohio's improved finances and to revisions in the foundation aid formula that are intended to benefit districts with higher numbers of students living in poverty.

Going forward, it is likely that revenue growth will be slightly below the rate of inflation, assuming voter approval of a four-year extension of the renewal levy in November. Risks could be skewed to the upside if Ohio's economy outperforms and/or the state increases the district's foundation aid allocation, either to offset shrinkage in Cleveland's taxable assessed value or to recognize a sustained turnaround in enrollments, should the latter occur.

The school district's legal ability to independently raise revenues is essentially nil. The school board has no ability to raise the millage rate without going to voters. The district has the ability to raise student tuition and fees, but no practical ability to do so in light of the impoverished background of many of its students. The district does not levy a local income tax, and has no immediate plans to pursue voter approval of one.

Expenditure Framework

Cleveland School District provides K-12 education to 39,000 public school students; as such, its primary expenditure items are payroll for teachers and support staff and building maintenance.

Overall expenditures are set to grow at above the rate of inflation and outstrip revenue growth, absent action by management to control costs. Major cost centers linked to employee salaries and, more particularly, to employee health insurance benefits, are likely to grow at a slightly faster rate than natural revenue growth given the economic realities of healthcare cost inflation and a large workforce that is moving to a new compensation system which includes merit pay. The district provides a broad range of services to students that include a large number of mandated services to address special and remedial education in a student population with high poverty and weak demographics. Extra service offerings partly explain the district's above-average per pupil cost ($14,427 in 2015 compared to the $10,466 state average).

Expenditure flexibility is adequate, taking into consideration the low carrying costs and flexibility afforded by the Cleveland Plan legislation, somewhat offset by a large percentage of charter school pass-through payments. The district benefits from low fixed carrying costs for debt service, pension contributions and other post-employment benefit (OPEB) payments, which together accounted for a modest 7.6% of expenditures in fiscal 2015. However, 19% of budgeted expenditures for fiscal 2016 were allocated to pass-through funding for local charter schools, which are funded with a portion of the district's state foundation aid. The district has no control over this line item, as it is required under Ohio law to pass a portion of its state aid to charter schools according to a per pupil formula.

Fitch believes the district's overall expenditure flexibility to be adequate based on its recent operating history. Management has demonstrated strong control over staffing levels, which have shrunk 21% since 2006 due to scheduled retirements, early retirement incentives and other reductions made to align the district's cost footprint with a smaller student body. The Cleveland Plan approved by the Ohio legislature in 2012 provides management a broad range of options for setting optimum staff levels and structuring school hours. This unique set of rules gives management greater flexibility to control program design costs, in some cases outside the normal collective bargaining framework. Within the latter, relations with bargaining units have sometimes been tense, and an open contract with the district's teacher's union is presently in mediation.

Long-Term Liability Burden

The district has a moderate long-term liability burden of $1.7 billion, equal to 14.4% of personal income. The bulk of the liability is made up of the district's proportionate shares of the total unfunded liability of the Ohio State Teachers' Retirement System (OSTRS) and the Ohio School Employees' Retirement System (OSERS). The district's combined pension and other post-employment benefits (OPEB) liability to the plans was reported at $779 million in 2015, based on 2014 actuarial data. Fitch estimates a slightly higher pension liability for the district of $1 billion using a slightly more conservative rate of return on assets. The two plans reported a combined ratio of assets to liabilities of 74.2%, assuming a 7.75% rate of return, as of June 30, 2015. Using Fitch's more conservative 7% rate of return, Fitch estimates a slightly lower ratio of assets to liabilities of 68.5% for the same year.

The remainder of the district's long-term liabilities is composed of $669 million of direct and overlapping debt, including $320 million of GO bonds issued to fund capital improvements. Amortization is slow, with only 24% of outstanding debt maturing within 10 years. Management has no immediate plans to issue additional bonds as it views the physical condition of district facilities as satisfactory as the result of a multi-year capital plan to replace older and obsolete school buildings that began in 2000 and has resulted in the demolition of many older schools and their replacement with a smaller number of new, up-to-date facilities.

Operating Performance

Fitch regards the district's ability to maintain financial resiliency through downturns as limited due its high fixed cost base when including substantial charter school-related expenses, inability to independently control revenues, and moderate reserve levels, although Fitch does not expect the district's revenue performance to be as volatile as suggested by the agency's scenario analysis tool if the 2012 renewal levy is re-approved for a second four-year period in November. Because two-thirds of revenues consist of state foundation aid, this portion of funding could be affected in proportion to Ohio state revenues during a recession. Fitch expects local property tax revenues to demonstrate less volatility going forward; past volatility captured by the agency's scenario analysis reflects approval of the renewal levy in 2012, along with large increases in state foundation aid in the 2008-2010 period under the prior state formula.

The management team has taken aggressive steps since 2012 to address a structural budget imbalance by implementing sizable cost reductions that have included school closures, elimination of some teaching positions and overall staff shrinkage, and negotiating for labor union concessions within the framework of the 2012 Cleveland Plan. Management has worked to implement cost reductions to better align facilities and teaching staff with a smaller student body. Enrollment declines since the early 2000's, which have been driven largely by charter school growth, had rendered some facilities unnecessary and made a rebalancing of staffing needs essential. Fiscal reserves, which had declined to negative $41 million in fiscal 2010 (equal to -6.2% of general fund revenues), were gradually replenished over several years, reaching $70.3 million, or 10.2% of revenues, in fiscal 2014. Fiscal 2015 concluded with a $5 million general fund operating deficit that reduced reserves to $65.4 million, equal to 9.3% of revenues.

Management estimates that fiscal 2016 concluded with a $5.1 million addition to fund balance. The fiscal 2017 budget includes a 3% increase in state foundation aid equal to $11 million. Management conservatively assumes that the 15-mill renewal levy will not be re-approved at mid-fiscal year, resulting in a large draw on reserves. Re-approval of the levy would bring operations close to structural balance. Management believes the district will be able to balance its budget through 2020 if the renewal levy continues for another four years, with modest draws on fund balance possible.

Voter re-approval of the renewal levy in November 2016 is the biggest wild card affecting the fiscal 2017 budget and performance. The U. S. presidential election on the same date supports high voter turnout, which could assist a re-approval outcome.