OREANDA-NEWS. Fitch Ratings has affirmed the 'A+' rating on Highlands County School Board, FL's (the district) bonds as follows:

--$3.4 million capital improvement and refunding revenue bonds, series 2014;
--$875,000 racetrack revenue refunding bonds, series 1999(pre-refunding);
--Implied unlimited tax general obligation (ULTGO).

The Rating Outlook is revised to Negative from Stable.

SECURITY

The revenue bonds are payable solely from an annual $223,250 distribution to the district from state sales tax revenues, pursuant to Florida statutes; the revenue is a substitute for racetrack revenues previously distributed. Highlands County (the county) is entitled to an annual fixed-dollar distribution of $446,500, of which the district directly receives one-half of that allocation. The distribution provides sum-sufficient coverage of level debt service to maturity.

KEY RATING DRIVERS

WEAKENED FINANCES DRIVE NEGATIVE OUTLOOK: Two consecutive years of deficit operations related to higher salary and wage costs have reduced district reserve levels to a thin 2% of fiscal 2015 spending. Though the fiscal 2016 budget is structurally balanced, the district will be challenged to rebuild reserves given spending pressure.

FIXED AND RELIABLE REVENUE SOURCE: Distributions to the board supporting revenue bond debt service are fixed and derived from the considerable sales tax receipts recorded within the state general revenue fund. Distributions provide for sum sufficient debt service coverage. The rating on the revenue bonds is capped at the lower of the district's implied ULTGO rating or one-notch below the state's 'AAA' GO rating.

STABLE ENROLLMENT AND TAX BASE: Modestly increasing enrollment supports growth in state per-pupil funding. The district is conservatively budgeting a slight enrollment decline in fiscal 2016. Tax base growth in fiscal 2014 marked the first period of improvement in the last six years.

MODEST LONG-TERM LIABILITIES: Debt levels are modest with no major capital needs. Pension obligations are provided through the state plan and are manageable while other-post employment benefit (OPEB) costs are minimal.

RATING SENSITIVITIES

STRUCTURAL BALANCE: Failure to realize balanced operations in fiscal 2016 with prospects for increasing reserves in the near term would likely lead to a rating downgrade. Conversely, balanced to surplus operations could result in a revision of the Outlook to Stable.

CHANGE IN DISTRICT OR STATE RATINGS: A change in the credit quality of the district or the state of Florida as it pertains to the pledged revenue source could cause a change in the rating on the revenue bonds.

CREDIT PROFILE

RELIABLE FUNDING SOURCE

The revenue bonds are payable from an annual $446,500 sales tax distribution allocated by the state to each county. The county has directed the board to directly receive its distribution per state statute. Formerly derived from taxes on pari-mutuel wagers, the state in 2000 substituted the 6% state sales tax as the source of funding after pari-mutuel wagering suffered significant declines. The state legislature may not modify the statutory scheme for the distribution of sales tax revenues in a manner that would impair the receipt by the board of sufficient pledged revenues to pay debt service on the bonds.

Sales taxes constitute the state's largest revenue source, exceeding $23 billion in fiscal 2014, providing ample receipts relative to its annual $30 million racetrack revenue distribution obligation. The fixed nature of the distribution and the size of the revenue source mitigate Fitch's concerns regarding very tight 1.0 maximum annual debt service (MADS) coverage provided for the local bonds and weak legal requirements, including the lack of a debt service reserve fund and the 1.0x MADS additional bonds test.

Like other Florida credits secured by fixed sales tax payments, Fitch's methodology caps the rating at the lower of the district's implied ULTGO rating or one notch below the state's GO rating.

CHALLENGED FINANCIAL OPERATIONS

After stimulus funds bolstered reserves in fiscal 2011, bringing unrestricted general fund balance to almost 10% of spending, reserves were drawn down in fiscals 2012 and 2013 to historical levels of about 4% to 6% of spending.

In fiscal 2014 the district underperformed budget due largely to personnel spending increases for added instruction and mandated employee raises, resulting in a $2.4 million deficit (2.8% of general fund spending). This deficit was partly offset by a prior period adjustment, and the district ended fiscal 2014 with about $3.5 million in unrestricted general fund reserves, equal to about 4% of fiscal 2014 expenditures.

For unaudited fiscal 2015, fund balance was eroded further despite 3.2% revenue growth. Expenditures increased by 2.2% due to ongoing cost increases related to lower than budgeted attrition and the addition of a planning period to the instruction schedule. Unaudited results point to another deficit of about $1.8 million, bringing unrestricted fund balance declined to $1.8 million, or a slim 2% of general fund revenues, below the district's fund balance policy and requiring state notification.

FISCAL 2016 BUDGET PROJECTS BALANCE

The fiscal 2016 budget includes revenue growth related to increased state aid and moderate spending reductions from attrition management. The budget is balanced without the use of reserves. Though the district has underperformed recent budgets, conservative state aid projections should offset potential shortfalls in expenditure reductions, as actual sources have exceeded budget by approximately $2 million for the last three fiscal years. Past budget shortfalls were primarily driven by higher than budgeted spending and fiscal 2016 budgeted expenditures appear more realistic relative to past performance. Fitch will monitor the district's financial performance closely, as expenditures are likely to dictate performance over the near term and continued fund balance erosion will likely result in a downgrade.

STABLE ENROLLMENT, IMPROVING TAX BASE

Enrollment performance has been stable with annual variances below 1% of the total student population. Enrollment has increased modestly in each of the last three fiscal years, providing upward potential for state funding, as state aid is allocated on a per-pupil basis. The district is conservatively projecting a modest enrollment decline in fiscal 2016.

The county's population rose significantly during the early and mid-2000s, but growth tailed off at the outset of the recession and has since been stagnant. Wealth values are well-below average with per capita income at less than three quarters of the state and national medians.

The unemployment rate for August 2015 was 7.8%, down from 9.3% the year before but still above the state (5.6%) and national (5.2%) averages. The improved unemployment metrics are partially due to decreases in labor force although employment did rise by 1.4%. Leading employers include the school board, Florida Hospital and Wal-Mart.

The district's primarily rural tax base has shown signs of recovery, as fiscal 2014 taxable value (TV) increased by a moderate 6.4%, following four consecutive years of recessionary decline. Continued modest growth is registered in fiscal 2016, though TV remains 20% below its pre-recession peak.

MODEST DEBT AND RETIREMENT OBLIGATIONS

Debt levels are modest with direct and overlapping debt to market value of 1% or $663 on a per capita basis. Debt service carrying costs also are manageable at 5% of fiscal 2015 general government expenditures, and amortization of direct debt is moderate at 60% of principal retired within 10 years. Capital needs are minimal and no other debt is planned.

Pension benefits are provided through the well-funded Florida Retirement System. The district's contribution in fiscal 2015 totaled $4.8 million or a modest 4.1% of general government spending. The district provides an implicit subsidy for OPEB. The subsidy is funded on a pay-go basis and the district's contribution for fiscal 2015 was a minimal $275,000. Total debt service, pension and OPEB carrying costs for the district in fiscal 2013 were a low 9.4% of governmental fund spending.