OREANDA-NEWS. Fitch Ratings affirms the following Gilroy Unified School District, CA (the district) bonds at 'A+':

--\$325,000 unlimited tax general obligation (GO) bonds, (election of 2002) series 2005.

The Rating Outlook is Stable.

SECURITY

The bonds are repaid from an unlimited ad valorem property tax levied upon all taxable property within the district.

KEY RATING DRIVERS

RETURN TO STRUCTURAL BALANCE EXPECTED: Fitch expects general fund structural balance to resume in fiscal 2016 as district revenues benefit from the state's local control funding formula (LCFF) and student population growth. The structural imbalance in fiscal years 2014 and 2015 is largely driven by employee remuneration increases.

LOWER THAN ANTICIPATED GENERAL FUND BALANCES: The district's general fund balances are projected to just miss the district's 5% general fund reserve goal for fiscal 2015 but to comply with its 6% and 7% reserve goals for fiscal years 2016 and 2017 respectively. These levels are lower than expected by Fitch in its previous review, but remain appropriate given the district's level of revenue growth and spending flexibility.

REBOUNDING ECONOMY AND TAX BASE: Economic indicators, including employment and tax base growth, continue to improve. Assessed valuation (AV) stands to benefit from considerable new development approved by the city of Gilroy.

MODERATE LIABILITY PROFILE: The district's long-term liability profile is characterized by high per capita debt, moderate amortization, constrained additional bonding capacity, and affordable carrying costs (which will rise over the next few years), with no post-employment benefits other than pensions.

RATING SENSITIVITIES

The rating is sensitive to shifts in fundamental credit characteristics including the district's maintenance of general fund reserve appropriate for its level of financial flexibility. The Stable Outlook reflects Fitch's expectation that the district's general fund balances will comply, at a minimum, with the district's reserve policy goals in fiscal years 2016 and 2017. Failure to meet those goals would likely have a negative credit impact.

CREDIT PROFILE

The 260 square mile district is located in southern Santa Clara County, 33 miles south of San Jose, and serves a population of just over 60,000. The district educates more than 11,000 students in eight elementary schools, three middle schools, three high schools, and the Gilroy Early College Academy.

RETURN TO STRUCTURAL BALANCE EXPECTED

The district posted general fund net operating surpluses after transfers in fiscal years 2011-2013, bringing the unrestricted fund balance up to 9.4% of spending. The improved financial performance was due primarily to expenditure reductions. These included a reduction in school days through furlough days and no salary increases for five years. The district restored the furloughed days in fiscal 2013 and began increasing remuneration in fiscal 2014 with a sizable 4.5% salary increase plus a 1% off-schedule common core implementation increase for certificated employees. As a result, the district posted a small net deficit after transfers of \$601,000 (0.7% of general fund spending) in fiscal 2014.

Even larger remuneration increases currently under negotiation will likely result in a more significant net operating deficit after transfers in fiscal 2015 of approximately \$3 million (2.9% of projected general fund spending). The district anticipates returning to structural balance in fiscal years 2016 and 2017 as increasing LCFF funding is expected to offset the district's labor cost increases. The district will continue to benefit from concentration grant funding related to its 60% unduplicated count of students who are English language learners, low income, or in foster care. The district also expects general fund revenues to be enhanced by ongoing gradual student enrollment growth as residential property development in the district resumes. In addition, students are being attracted by the district's improved academic performance and greater range of academic course offerings. However, Fitch notes that previous budget projections did not eventuate.

LOWER THAN ANTICIPATED GENERAL FUND BALANCES

In its previous review, Fitch anticipated that the district's unrestricted general fund balance would remain at least 9% through fiscal 2016. This projection has now been lowered. The district expects that its unrestricted general fund balance might not quite achieve its own 5% general fund reserve policy for fiscal 2015. However, the district is confident that the unrestricted general fund balances in fiscal years 2016 and 2017 will meet the district's policy goals of 6% and 7% respectively. Fitch considers that such unrestricted general fund balance levels, if attained, would remain adequate given other aspects of financial flexibility, including the district's level of revenue and expenditure flexibility related to staffing ratios, class sizes, and deferred maintenance.

REBOUNDING ECONOMY AND TAX BASE

The city of Gilroy, historically an agricultural and food processing center, experienced rapid growth during the housing boom due to an influx of Silicon Valley residents, followed by contraction due to the economic downturn. Now, during the latest upcycle, the city's unemployment rate has dropped markedly, its population continues to grow, and the city's AV is rebounding well.

Unemployment, historically on the high end due to the district's large agricultural sector, fell sharply to a still high 7.8% in November 2014, down from 9.4% a year prior, based on strong growth across a number of employment sectors. Median household incomes remain significantly above state and national averages, though lower than the county and MSA likely due to elevated incomes in the nearby tech center of Silicon Valley. Nevertheless, 57.7% of the district's students are eligible for free or reduced-price lunches.

The district's AV increased 6.5% in fiscal 2014 and 7.2% in fiscal 2015, almost fully recovering the valuation lost during the economic downturn. The district expects further AV growth as the city has approved developments which will generate between 300-400 new dwellings annually for the next 5-8 years. More than 2,000 houses have already been permitted for construction.

MODERATE LIABILITY PROFILE

Overall debt levels are high on a per capita basis (\$6,175) but only moderately high when measured against the district's rebounding AV (4.5%). Amortization is moderate with 42.4% of principal repaid within 10 years. The district expects to issue its remaining \$28.95 million GO bond authorization in two tranches, in 2017 and 2027, depending on its ability to do so given AV growth, interest rates, and the Proposition 39 limit (\$60 per \$100,000 AV). The district is currently at that limit, but expects some headroom to open up in 2017 which will allow it to begin issuing new debt for construction of a planned elementary school. As a result, Fitch expects the district's debt levels to remain moderately high for some time.

The district participates in two state pension plans, the California Public Employees' Retirement System (CalPERS) and the California State Teachers' Retirement System (CalSTRS). CalPERS contributions are actuarial, but the CalSTRS contributions are statutory and have been below the actuarially required contribution for several years. This practice is contributing to the CalSTRS's low funding level and creating significant contribution increases for several years going forward. The district anticipates that its general fund will absorb these contribution cost increases as well as expected CalPERS contributions.

Total debt repayment and annually required pension contribution carrying costs were a manageable 13.7% of total governmental spending in fiscal 2014. The district does not offer other post-employment benefits. Carrying costs will likely rise due to increased pension contributions and future debt issuances.