OREANDA-NEWS. Fitch Ratings has affirmed the following Merced City School District (the district), CA ratings:

--\$2.7 million outstanding general obligation (GO) bonds, series 2004 at 'AA-';
--\$8.5 million outstanding GO bonds, series 2005 at 'AA-'.

The Rating Outlook is Stable.

SECURITY

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

KEY RATING DRIVERS

CONCENTRATED ECONOMY: The local economy is concentrated in agriculture and food processing, with correspondingly low incomes and high unemployment. Diversification is being spurred by ongoing growth at the University of California's newest campus in Merced.

SOUND FINANCIAL PROFILE: The district's general fund is benefitting from increasing revenues under the state's new local control funding formula (LCFF), student enrollment growth, strong fund balances, and good liquidity.

REBOUNDING, DIVERSE TAX BASE: In fiscal years 2013 and 2014, the district regained approximately half of the 28.6% assessed value (AV) loss it experienced during the recent recession. There is no single property taxpayer concentration.

MANAGEABLE DEBT BURDEN: The district's debt ratios are expected to remain moderate when additional debt is issued. The district's debt, pension, and other post-employment benefit (OPEB) carrying costs are very affordable.

RATING SENSITIVITIES

STRONG FINANCIALS OFFSET WEAK SOCIOECONOMIC CHARACTERISTICS: The rating assumes no material change in the near term to the district's strong general fund balances and moderate debt burden, which together help offset its weak socioeconomic profile.

CREDIT PROFILE
The district is located in Merced County (the county), approximately 110 miles southeast of Sacramento, with a population of around 86,000. The district serves most of the city of Merced, a small portion of the city of Atwater, and unincorporated county areas with 13 elementary and four middle schools.

SOLID GENERAL FUND POSITION; CONSIDERABLE FINANCIAL FLEXIBILITY

The district has significantly built up its general fund balances over the past six years, despite volatile state funding and a recession which affected the county particularly harshly. It maintained structurally balanced operations in all but one of those years, ending fiscal 2014 with a net surplus after transfers of \$3 million. This allowed the district to end fiscal 2014 with a solid unrestricted general fund balance of \$19.3 million or 23.4% of spending.

The district is currently projecting largely breakeven general fund operations in fiscal 2015 despite interim reports indicating net deficits of up to \$4.6 million. The district expects to outperform such interim projections due to savings from position vacancies and under-expenditures in its personnel, teacher substitute, professional development, and services and supplies budgets. The district typically outperforms its budgets and interim projections.

The district also stands to benefit greatly from LCFF because it has a very high unduplicated count of students who are English language learners, low income, or in foster care (84.7%). As a result, the district receives considerable supplemental concentration funding which both bolsters its general fund revenues and provides considerable financial flexibility going forward. The district would be able to reduce its expenditures on non-core supplemental services being funded by LCFF in the event of an unexpected revenue downturn. However, at present the district is expecting to outperform its projected surplus general fund operations in fiscals 2016 and 2017. This outperformance will be supported in part by anticipated student enrollment growth as the local population continues to grow and more new housing is built.

The district's labor agreements are typically flexible with regard to salary reopeners, furloughs, layoffs, binding arbitration, regional compensation comparisons, and class size requirements. Management advises that it has a collaborative working relationship with the district's bargaining units.

CONCENTRATED ECONOMY, CONSTRAINED SOCIOECONOMIC CHARACTERISTICS

The San Joaquin Valley agriculture and food processing-based economy has experienced modest diversification and steady population growth over the past decade but was severely impacted during the recent recession. The city of Merced's unemployment rate remains very high at 12.1% in November 2014, although down from 13.1% a year prior. Income levels and educational attainment are both well below state and national levels.

The ongoing expansion of the University of California's newest campus, UC Merced, is a key development for the district's economy and will likely help diversify employment as student enrollment levels continue to grow. The campus currently serves approximately 6,300 students and plans to increase enrollment to 10,000 by 2020. The university is actively engaged in construction of its new campus and estimates its direct investment in the local economy at \$1.1 billion between 2000 and 2014.

REBOUNDING, DIVERSE TAX BASE

UC Merced's presence also contributed to a speculative property boom that sharply reversed course during the recession. After growing through the construction and opening of UC Merced, AV peaked in fiscal 2008 when it increased 10.5% in just that year. However, AV subsequently declined 28.6% between fiscals 2009-2013.

Since then, the district's AV has regained approximately half of that loss, with a 4.1% increase in fiscal 2014 and a 9.7% increase in fiscal 2015. Positive indications include fewer Proposition 8 reassessments, renewed developer interest in residential construction, and some medical office construction. However, the planned 1.2 million square foot WalMart distribution center project, which was projected to employ 1,200 staff, has been put on hold despite receiving planning permission.

Single taxpayer concentration is low with the largest taxpayer, World Color Press Inc., an industrial offset and photolithographic printer, accounting for only 2.5% of 2014 AV. Other leading taxpayers are a diverse mix of commercial and industrial properties with none comprising over 0.7% of 2014 AV.

As a result of the past AV declines and the strength of the GO pledge, the district projects raising tax rates up to 43% higher than originally projected for debt service on the series 2004 and 2005 GO bonds. The district is using defensible, but not conservative, annual AV growth rates in its tax rate projections. District tax levy collections are supported 100% by the county irrespective of delinquencies.

MANAGEABLE DEBT, LONG-TERM LIABILITIES

Overall debt levels are moderate at an estimated \$1,870 per capita or 3.7% of AV. Debt amortization is also moderate with 49.3% repaid in 10 years when capital appreciation bonds' accreted interest is treated as principal. Debt levels would remain manageable in the event that \$15 million-\$18 million in new debt is issued in the next 2-5 years for continuation of school facility modernization projects.

The district participates in two state pension plans, the California Public Employees' Retirement System (CalPERS) and the California State Teachers' Retirement System (CalSTRS). In fiscal 2014, the district again contributed 100% of the annually required contribution (ARC). CalPERS contributions are actuarial, but the CalSTRS contributions are statutory and have been below the ARC for several years, contributing to its low funding level and creating the need for significant contribution increases going forward. The district is confident that rising pension contribution costs can be absorbed by the general fund.

In fiscal 2014, the district contributed \$2.3 million towards OPEB, above its actuarially-determined OPEB ARC of \$1.8 million, in order to reduce its unfunded liability. Similarly, the fiscal 2015 budget includes a \$2.4 million contribution that is greater than the \$2.1 million ARC. The district's unfunded actuarial accrued liability is currently estimated to be a manageable \$25.1 million (approximately 0.5% of fiscal 2015 AV). At June 30, 2014, the district had set aside \$4.2 million in an irrevocable OPEB trust. The district's exposure to future OPEB cost increases is curtailed by a cap on retiree health care costs. However, that cap (\$1,023 per month for most employees) has increased 17.9% since Fitch's previous review.

In fiscal 2014, the district's overall carrying costs for annual debt repayment, actuarially required pension contributions, and pay-as-you-go OPEB payments was a very affordable 8.7% of all governmental spending.