OREANDA-NEWS. Fitch Ratings has affirmed Reef Sunset School Financing Authority, California's general obligation bonds (GOs) as follows.

--\$5.3 million GO bonds, series 2007 at 'A'.

The Rating Outlook is Stable.

SECURITY
The bonds are payable from an unlimited property tax on all taxable property within the district.

KEY RATING DRIVERS

DECLINING BUT ADEQUATE RESERVES: Reef Sunset Unified School District, California (the district) expects general fund operations to produce a fourth consecutive year of deficit spending in fiscal 2015, lowering projected reserves to satisfactory levels (from previously healthy totals). State funding is projected to increase over the short term, and management has a plan to bring operations into balance in fiscal 2016.

EXPENDITURE PRESSURES REMAIN: Recent and expected future revenue increases are offset to a significant extent by numerous expenditure pressures. These pressures include employee wages, service level restorations and enhancements, and substantial scheduled CalSTRS contribution rate hikes.

CONCENTRATED ECONOMY: The local economy and tax base is highly concentrated in the oil and gas sector, and is characterized by weak income and poverty levels and high regional unemployment. Recent and substantial oil price declines, if prolonged, could lead to negative secondary effects on the district's assessed value (AV), GO tax rates, unemployment, and enrollment.

ADEQUATE DEBT PROFILE: The district's debt profile is weighed down by participation in the poorly funded CalSTRS, an unfunded OPEB liability with pay-go funding, and significant use of capital appreciation bonds (CABs) with slow amortization. These weaknesses are mitigated by just moderate debt levels and modest capital needs.

SATISFACTORY MANAGEMENT PRACTICES: The district's fund balance policy is double the state minimum and the district benefits from the community's strong history of support for GO authorizations. Like all California districts, Reef Sunset USD is subject to strong financial reporting, forecasting, and oversight provisions.

RATING SENSITIVITIES

FINANCIAL STABILIZATION: An inability or unwillingness to balance the district's financial operations, leading to further material deterioration of the district's financial profile, could lead to negative rating action. The Stable Outlook reflects Fitch's expectation that operations will not weaken to a sufficient degree to warrant such action over the coming review cycle.

CREDIT PROFILE

The district is located in northwest Kings County near interstate 5, about 70 miles southwest of Fresno and 85 miles northwest of Bakersfield. It serves about 2,600 students in grades K-12 in the cities of Avenal and Kettleman.

The regional economy is dominated by oil, agriculture and state prisons. About one-third of the estimated district population of 17,300 is in the Avenal state prison, which is also one of the largest employers in the area. Despite the prison's large presence, management reports that the large majority of local residents work in agriculture.

LOW-INCOME STUDENT POPULATION

The county economic profile is weak (data is not available for Avenal), as is common for agriculturally-concentrated regions. Unemployment is high at 11.7% and income levels are very low. Nearly all of the district's student population is eligible for free and reduced-price lunches, which positions the district well under the state's Local Control Funding Formula (LCFF). LCFF is being phased in over a multi-year period and allocates a higher proportion of Proposition 98 funding to schools with higher populations of economically disadvantaged, English-learning, and foster care youths.

The district's AV levels generally have fared well over the past several years due to commodity price gains. However, recent and substantial declines in the price of oil may lead to a major AV loss in fiscal 2016. The most recently available AV breakdown (fiscal 2013) showed considerable concentration with the top 10 taxpayers making up 37% of the total, and oil and gas-related concerns making up 40% of the top 10.

Because of the state's school district funding mechanism, any lost local property tax revenues for operations will be entirely back-filled by state funding. However, over the long term, the district's greater reliance on state funding would leave it more exposed to state funding fluctuations, should they occur again as they have in previous episodes of state fiscal stress.

WEAKENING FINANCIAL POSITION

The district's financial operations are in their fourth year of structural imbalance due to just-moderate expenditure reductions during the funding downturn, followed by wage hikes in fiscals 2014 and 2015. The district's first interim financial report projects a \$1.2 million operating deficit in fiscal 2015, lowering the total and unrestricted general fund balances to still satisfactory levels of \$4 million (15.2% of expenditures and transfers out) and \$2.8 million (10.7%), respectively. Due to budgeting conservatism, the district will likely outperform its projected deficit to some extent. The district's unrestricted fund balance peaked at \$5.5 million (24.6%) in fiscal 2011, by comparison.

Management has identified about \$1 million of expenditure reductions they view as likely to be implemented in fiscal 2016. These reductions, in conjunction with significant projected short-term funding gains included in the governor's proposed fiscal 2016 budget, would close or substantially close the district's structural deficit. Any material negative deviation from this projection and subsequent further weakening of the district's finances would not be consistent with the current rating.

SPENDING PRESSURES CONTINUE; FLEXIBILITY REMAINS

Despite identified cuts for fiscal 2016, various other expenditure pressures will challenge the district's ability to restore and then maintain balanced operations moving forward, despite forecasts of funding gains. The state's fiscal 2015 budget included a CalSTRS contribution rate hike of more than 100% by fiscal 2021, to be phased in incrementally each year. The state projects funding gains will offset these increased costs; however, the elevated rates are projected to last for 32 years. Long-term vulnerability to structural imbalance is a concern, as fixed costs rise and state funding inevitably fluctuates through economic cycles over such a long period.

Fitch believes the district is also likely to experience expenditure increases related to pent-up wage and service level pressures. Prior to fiscal 2014, certificated employees (predominantly teachers) had not received wage increases for some time. As funding levels have begun recovering so too have wages, with increases of 6% and 2.2% in fiscals 2014 and 2015, respectively. The district has also begun adding back services that were cut during the recession.

Fitch views the district's remaining legal expenditure flexibility (after anticipated cuts are made in fiscal 2016) to be somewhat high due to relatively small class sizes, the ability to implement furlough days, and the continued operation of programs that are not legally required. Also, the state has historically provided enhanced expenditure flexibility to school districts during material funding downturns. However, political considerations could impede expenditure flexibility before legal limitations are reached.

Maintenance of a solid financial position will require the board to judiciously balance further wage and service level enhancements with targeted expenditure cuts, as appropriate, to prevent material financial deterioration.

LONG-TERM LIABILITY BURDEN INCREASING

The district's debt profile is weighed down by very slow amortization resulting from the district's significant use of CABs, participation in the poorly-funded CalSTRS, and a significant OPEB liability. These weaknesses are somewhat mitigated by an affordable debt burden (total debt equals \$1,479 per capita, or 3% of AV), and limited capital needs due to recent years' capital improvements.

Carrying costs, while currently manageable, are likely to climb moving forward based on scheduled CalSTRS rate hikes and the district's practice of paying OPEB on a pay-as-you-go basis.