Fitch Rates Redwood City SD, CA's $60MM Unlimited Tax GOs 'AAA'; Outlook Stable
--$60 million GO bonds (2015 election), series 2016.
In addition, Fitch has assigned an Issuer Default Rating (IDR) of 'A+' to the district.
The Rating Outlook is Stable.
The 2016 GO bonds are expected to sell via negotiation on Aug. 25, 2016. Bond proceeds will address some of the district's capital facility needs.
SECURITY
The bonds are secured by unlimited ad valorem property taxes levied on all taxable property within the district.
KEY RATING DRIVERS
SPECIAL REVENUE ANALYSIS: The 'AAA' rating on the series 2016 GO bonds is based on a dedicated tax analysis without regard to the district's financial operations. Fitch has been provided with legal opinions by the underwriter's counsel that provide a reasonable basis for concluding that the tax revenues levied to repay the bonds would be considered 'pledged special revenues' in the event of a district bankruptcy.
GROWING TAX BASE; LOW DEBT: The economic resource base supporting the GO bonds is strong, diverse, and growing. The unlimited nature of the tax offsets any concern about tax base volatility. The district's debt burden is low relative to the tax base.
RATING SENSITIVITIES
Tax Base Drives GO Rating: The 'AAA' GO bond rating is sensitive to a significant and long-lasting decline in the district's tax base and economy, which Fitch considers unlikely.
CREDIT PROFILE
The district is well located in San Mateo County, between two major freeways connecting the vibrant, diverse San Francisco and Silicon Valley employment markets. The district consists primarily of Redwood City (the county seat) and portions of surrounding cities and unincorporated county. Despite rising housing prices, Redwood City remains one of the comparatively more affordable communities in the southwestern portion of the Bay Area. The district's tax base growth has been strong. The unemployment rate has improved significantly in recent years. Income metrics and educational qualifications are well above state and local rates.
Tax Revenue to Repay Bonds Viewed as Pledged Special Revenues
Fitch believes that taxes levied for bond repayment would be considered pledged special revenues under the U. S. bankruptcy code and therefore the lien on pledged revenues would survive and would not be subject to the automatic stay (i. e. payment interruption) in the event the district were to file for bankruptcy. Fitch has reviewed and analyzed legal opinions provided by the underwriter's counsel and believes they provide a reasonable basis to conclude that these revenues would be treated as pledged special revenues due to certain provisions of the state constitution (primarily Proposition 13), which limit and direct the use of pledged property tax revenues for bond repayment.
As a result, Fitch analyzes these bonds as dedicated tax bonds. This analysis focuses on the district's economy, tax base, and debt burden without regard to financial operations because Fitch believes that bondholders are insulated from any operating risk of the district. Fitch typically calculates the ratio of available revenues to debt service for dedicated tax bonds, but the unlimited nature of the tax rate pledge on the district's bonds eliminates the need for such calculations.
The $22 billion tax base is a diverse mix of residential, commercial, and industrial properties which proved to be very resilient during the recession. Concentration is low with the top 10 taxpayers accounting for approximately 9% of AV. After a sole 1% decline in fiscal 2011, taxable assessed valuation (AV) more than rebounded by 30% through fiscal 2016. The county assessor projects 9% further taxable AV growth in fiscal 2017.
The prospects for continued growth are very good due to residential housing construction either underway or permitted, plus commercial expansion. For example, the most valuable single property within the district is owned by Google, which plans to develop it into a satellite campus after existing tenants' leases expire. After declining during the recession, housing prices have rebounded sharply, a likely beneficiary of the Bay Area's tight housing market. The sale of existing properties results in the reassessment of their taxable values to market levels.
IDR Expands Analysis to Include Operating Performance and Framework
The 'A+' IDR considers the district's strong gap closing capacity as well as its future fiscal challenges. The district is currently benefitting from improved state education funding, in part because of its moderate unduplicated count of targeted students. However, sustained declining student enrollment contributes to fiscal challenges as enrollment drives a large portion of revenues. The IDR also incorporates the district's low long-term liability burden, rising but still moderate fixed costs (including retiree benefit costs), and demonstrated ability to contain spending as needed.
Economic Resource Base
As with most California school districts, the bulk of the district's operational revenues are derived from a state-determined per pupil funding formula, although capital funding is largely locally funded. The district serves approximately 8,400 transitional kindergarten through grade 8 students at 16 school sites. Competition for students comes from three fiscally independent charter schools operating within the district's boundaries. These charter schools serve approximately 700 students and have the capacity to absorb more.
Revenue Framework: 'bbb' factor assessment
Despite student enrollment declines, general fund revenues have rebounded in recent years due to state economic improvement and the district's moderate unduplicated count of targeted students, and further slow growth is expected. However, the district's independent legal ability to raise revenues is constrained by state law which requires voter approval for tax increases.
Expenditure Framework: 'aa' factor assessment
The district has a moderate but rising fixed cost burden and solid flexibility to adjust spending.
Long-Term Liability Burden: 'aaa' factor assessment
The long-term liability burden is low relative to the district's economic resource base. The district participates in two adequately funded state-run pension plans and its unfunded OPEB liability is miniscule relative to the tax base.
Operating Performance: 'a' factor assessment
The district maintains reserves above its minimum policy level, providing a valuable financial cushion. Fitch assesses the district's gap closing capacity as strong relative to the expected revenue loss (2%) during a 1% GDP decline scenario.
Revenue Framework
State aid and local property taxes provide the majority of district operating revenues. State aid has been expanding due to improvements in the state's economy and a new local control funding formula (LCFF) which provides additional funding for targeted students. In its fiscal 2017 budget, the district estimates that at least 61% of its students will be English language learners, eligible for free or subsidized lunches, or in foster care. Actual general fund revenues grew by 13% during fiscals 2013-2015, notwithstanding student enrollment declines.
The district has experienced declining average daily attendance over the past few years due to charter school competition. Between fiscal years 2014-2016, the district's average daily attendance declined by almost 7%. By fiscal 2018, the aggregate decline is projected to have increased to almost 11%. The district is working to reverse this downward trend by better marketing of its language immersion, gifted and talented, and project-backed learning programs. It also expects to benefit from new residential development which appears to be attracting young families to the area. The district reports that approximately 1,400 new residential units have been recently completed or are under construction and the district is projecting that there could be 0.4 students per unit (560 students in total) which could offset some of the enrollment losses to the charter schools.
State law requires voter approval of tax increases, limiting the district's independent legal ability to control revenues. However, Fitch expects that the district will continue to manage its revenue pressures satisfactorily and, with voter support, it might be able to slightly increase its locally generated revenues. After several failed attempts, a parcel tax passed in June 2012 generating $1.5 million per year (less than 2% of projected fiscal 2016 general fund revenues), based on $67 per parcel. The parcel tax is due to expire in June 2017 and the district is likely to seek voter approval in November 2016 for an extension. The district estimates that it would generate $1.9 million per year, based on $85 per parcel. Polling indicates strong voter support.
Expenditure Framework
Fitch expects general fund expenditure growth to be in line with, or to slightly exceed, general fund revenue growth due in part to meet rising employee remuneration costs. In fiscal 2016, to ensure more competitive salaries relative to neighboring districts, employees received a 5% remuneration increase, of which 3.5% was retroactive to July 1, 2015. In fiscal 2017, the district is budgeting almost 82% of its general fund expenditures on personnel.
Special education is another cost pressure. In fiscal 2017, the district projects it will spend over $14 million of unrestricted general fund monies to comply with unfunded federal and state special education requirements.
The district's mandate to provide educational services places some limitations on its ability to make expenditure reductions in the event of a revenue decline. Nevertheless, the district maintains solid expenditure flexibility. The district's debt, pension, and OPEB carrying costs represent a moderate 15% of governmental expenditures. Furthermore, the district has the ability to lay off or furlough employees, raise class sizes under existing labor contracts, reduce non-mandatory supplemental program offerings, and defer non-essential expenditures. These options are supported by the district's moderately flexible labor environment.
Long-Term Liability Burden
In fiscal 2016, the district's long-term liability burden (overall debt plus adjusted unfunded pension liabilities) is low relative to its resource base at about 7% of personal income. The burden is mostly comprised of overlapping debt (63% of the total), with the remainder split roughly equally between direct debt and pensions. The bulk of the district's direct debt is funded from an unlimited property tax levy restricted to this purpose. Direct debt amortizes by approximately 47% in 10 years.
The 2015 election garnered almost 64% voter support for up to $193 million in GO bonds. The upcoming $60 million 2016 GO bond issuance will leave $133 million in authorized bonds to be issued in two to three tranches from fiscal 2019 onwards, as existing GO debt rolls off. Even after issuance of the full authorization, the district has identified a further $137 million in capital needs that are currently unfunded.
The district participates in two state-funded pension systems, both of which are mandating increasing employer contributions over the next few years to improve their funded ratios. As of June 30, 2016, the district's proportionate share of CalSTRS' and CalPERS' net pension liabilities was $64 million (assuming 7.6% and 7.5% discount rates, respectively). Using Fitch's more conservative 7% discount rate, the district's proportionate share increases to an estimated $83 million but remains well under 1% of the district's fiscal 2016 AV.
Operating Performance
During the recession, the district demonstrated its ability to make difficult resourcing decisions by laying off teachers and furloughing administrative staff. These cost control techniques, along with attrition and managed hiring, remain available to the district as it manages its expenditures in a falling student enrollment environment. However, some of these options might prove harder to implement outside of a recession, particularly given the district's desire to compete with charter schools and more affluent neighboring school districts, and address community pressure for smaller class sizes.
Fitch expects the district to exercise its strong gap closing capacity to maintain its good reserves. The board has a minimum unrestricted fund policy of 6%. It consistently complies with this through a combination of the unrestricted fund balances in the general fund and the capital facilities fund (Fund 25). The district expects that Fund 25 will receive approximately $850,000 annually from successor agency agreements for the next 15 years which will help offset pressure on the unrestricted general fund balance.
The district generated net operating general fund deficits after transfers in fiscals 2012-2014 resulting from its support for enhanced education programs and improved teacher remuneration. The district returned to positive operations in fiscals 2015 and 2016 (projected) due to improved state funding and LCFF.
The general fund ended fiscal 2015 with an unrestricted general fund balance of $5 million or almost 6% of spending. This represented an improvement from its prior year unrestricted general fund balance of less than $3 million or 3% of spending, the lowest level in recent years. Fund 25 ended fiscal 2015 with an unrestricted fund balance of nearly $4 million. The two funds' projected combined unrestricted balance of approximately $9 million equates to almost 10% of general fund spending.
The district projects further general fund strengthening at fiscal 2016 year end when the unrestricted general fund balance is expected to increase to approximately $8 million (8% of spending). Fund 25 is expected to end fiscal 2016 with an unrestricted fund balance of almost $4 million. The two funds' projected combined unrestricted balance of nearly $12 million equates to approximately 12% of general fund spending.
While the fiscal 2017 general fund budget shows a $2.6 million net operating deficit after transfers, the district expects to end with a much smaller drawdown, in large part because it will not be able to spend all of the $1.9 million in one-time funds it is due to receive that year. The district's conservative multiyear projections indicate two years of general fund drawdowns in fiscals 2018 and 2019 as costs continue to rise despite further student enrollment declines. The district projects that the unrestricted Fund 25 balance will ensure its ongoing compliance with the 6% unrestricted fund balance threshold through fiscal 2019.
The district is exploring how best to close these gaps in terms of both revenues (reversing the declining student enrollment trend) and expenditures (reducing costs) while meeting its 6% unrestricted fund balance threshold (with Fund 25's support). Voter approval in November 2016 to extend both the local parcel tax and the state Proposition 30 temporary income tax increase would help maintain local and state education funding levels. Fitch assesses the district's gap closing capacity as strong relative to the expected revenue loss (a manageable 2%) during a 1% GDP decline scenario.
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