OREANDA-NEWS. Fitch Ratings has downgraded the following rating for Bear Valley Unified School District (the district):

--$16.1 million general obligation (GO) bonds to 'A+' from 'AA-'

The Rating Outlook is Stable.

SECURITY

The bonds are backed by an unlimited ad valorem property tax levy.

KEY RATING DRIVERS

OPERATING DEFICITS, REDUCED RESERVES: The downgrade reflects annual operating deficits in recent years that have significantly eroded the district's reserves. Near-term budget projections indicate a return to balanced operations and growth in reserves, but will be affected by the outcome of labor contract negotiations, including final decisions on salary increases for the current year.

ENROLLMENT DECLINES: District enrollment continues to decline. Projected additional near-term declines of 3% annually will pressure district finances, as state funding is based on enrollment.

NARROW ECONOMY: The local economy, dependent on the potentially volatile tourism sector, has stabilized in recent years following recessionary weakness. Taxable assessed value (TAV) remained flat in fiscals 2013 and 2014, followed by growth in fiscals 2015 and 2016. Local unemployment levels have been declining, but remain above average. Wealth and income indicators are below average.

MANAGEABLE LONG-TERM LIABILITIES: While debt is average as a percentage of market value, it is high on a per capita basis given the preponderance of second homes. Carrying costs for debt service, pension, and other post-employment benefit (OPEB) costs remain manageable but will increase due to planned increases to address poor funding of state pension plans.

RATING SENSITIVITIES

FINANCIAL STRENGTHENING: The 'A+' rating assumes near-term financial stabilization, including balanced operations and no material declines in reserves. A weakened financial position, particularly if there is reliance on reserve balances for operational needs, would likely pressure the rating.

CREDIT PROFILE

The district is located in the San Bernardino Mountains, approximately 120 miles east of Los Angeles County. The district serves about 2,300 students from the city of Big Bear Lake and unincorporated portions of San Bernardino County.

DEFICITS CONTINUE IN FISCAL 2015; NEAR-TERM OPERATING SURPLUSES PROJECTED

Declining enrollment and state fiscal distress led the district to experience six consecutive years of general fund net operating deficits after transfers, resulting in ongoing reserve drawdowns. Fiscal 2015 ended with a general fund net operating deficit after transfers of $360,530 (1.5% of spending) driven by salary increases. Though the deficit was lower than the prior three years (annual deficits of about $900,000 or 4% of spending), it contrasted with prior expectations for an end-of-year surplus, initially budgeted at $533,742. The resulting fiscal 2015 unrestricted general fund ending balance was $923,677 or 3.7% of spending, which is comparable to the prior year (3.5%) but still significantly lower than fiscal 2013 (10.2%).

The district also maintains a special reserve for capital outlay, with a fiscal 2015 unrestricted balance of $1.2 million (4.8% of general fund spending) and a current balance of about $1.1 million. This is a set-aside of general fund monies for capital spending which is fully available for any general fund spending at the school board's discretion. Including this reserve, the fiscal 2015 unrestricted general fund balance is still a low 8.5% of spending.

An improved state revenue picture, reflecting implementation of the local control funding formula (LCFF) and passage of temporary income and sales taxes, resulted in the district opting to increase spending in recent years, including spending for additional staff, restoration of planned management furlough days, and salary increases. Going forward, the district has indicated a commitment to stabilizing finances, including better matching of staffing to enrollment needs. Expenditure controls have included staffing reductions achieved through attrition and elimination of certain positions, together with expected savings from infrastructure upgrades meant to decrease energy costs.

Multiyear projections indicate operating surpluses in fiscals 2016 through 2018 that would increase total general fund ending balances to over 10%. In addition, available balances in the special reserve for capital outlay are expected to total about $1 million in these years. While the district currently has no plans to spend down this special reserve, there is no formal minimum fund balance requirement to maintain its current funding level. The district's general fund balance policy requires maintenance of reserves at 4% of spending, but the district is targeting reserves above this level. The actual amount will be determined by actual revenue and expenditure performance. In addition, state legislation dependent on meeting certain state level financial triggers could limit general fund reserves to 6% of spending.

IMPROVED LIQUIDITY

In fiscal 2013, the district borrowed $3.8 million from San Bernardino County to offset cash shortfalls caused by large state deferrals. This amount was repaid early and the district then issued $1.1 million in tax revenue anticipation notes (TRANs). For fiscal 2014, county borrowing totalled $1.7 million, but no TRANS were issued. The district relied on internal borrowing from available funds outside the general fund (the special reserve for capital outlay and the redevelopment agency fund) for fiscals 2015 and 2016 ($1 million and $2 million, respectively). Fiscal 2017 cash flow projections do not include any borrowing, though some internal borrowing is expected to be needed. The district expects ongoing annual borrowing to address standard cash flow issues related to a timing mismatch of revenues and expenditures. Fiscal 2016 balances in the special reserve for capital outlay and the redevelopment agency fund are estimated at about $1.1 million and $2 million, respectively.

DELINQUENT DEBT SERVICE PAYMENT

The district cites administrative issues, including staff on vacation and issues with the receipt of notification e-mail, as the reason for a one-day delay in a $159,994 COPS debt service payment due Oct. 1, 2015. Fitch's review of cash balances at the time of the payment due date demonstrates sufficient cash was on-hand to make timely payment. Fitch is comfortable that the missed payment was an administrative error, but it does cause concern over management practices. The district has indicated that it has taken measures to assure future timely payments, including better coordination with the bond trustee. The district has requested that the bond trustee send debt service invoices at least 60 days in advance of the debt service payment due date, allowing ample opportunity for timely payment. Payment for the upcoming April 1, 2016 COPs debt service payment was made in January.

NARROW ECONOMY WITH BELOW-AVERAGE SOCIOECONOMIC INDICATORS

The district's local economy is heavily focused on tourism, with many of its largest taxpayers and employers in the recreation/ hospitality sectors. Area unemployment has been declining, but still exceeds the national level. The San Bernardino county unemployment rate was 5.8% in December 2015, comparable to the state rate but exceeding the national rate of 4.8%. Income and wealth figures are below average. After annual declines since fiscal 2010, taxable assessed value (TAV) stabilized, remaining flat in fiscals 2013 and 2014, with growth in fiscal 2015 (3.6%) and 2016 (4.9%).

LONG-TERM LIABILITIES ARE MANAGEABLE

The district's overall fiscal 2015 debt burden remains manageable, though indicators are mixed due to the large number of seasonal homes in the area. Debt per capita is high at $6,615 but moderate at 2.3% of market value. Fiscal 2015 debt service as a percentage of governmental spending is also moderate at 8.9%. Principal amortization is average, with about 56% retired in 10 years. District debt levels should remain manageable as the district has no immediate plans for further debt issuance.

District employees are covered under the California State Teachers' Retirement System (CalSTRS) and the California Public Employees' Retirement System (CalPERS). The plans' fiduciary net position as a percentage of total pension liability are 77% for CalSTRS and 83% for CalPERS, or an estimated 72% and 79%, respectively, based on Fitch's 7% rate of return. At June 30, 2015, the district's proportionate share of CalSTRS's and CalPERS's net pension liabilities was $14.8 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 $19.1 million, or a low 0.3% of the district's fiscal 2015 AV.

The district's total carrying costs, including debt service costs, actuarially determined pension contributions, and OPEB pay-as-you-go payments are moderate at about 17% of governmental spending. However, carrying costs will increase as planned pension contribution rates rise to address substantial unfunded liabilities in the state pension systems. Funding for CalSTRS is a particular concern, as statutory contributions have been well below the level required to amortize existing obligations.