TEXT-Fitch cuts Eastside USD, Calif. GOs to 'A-'

Tue Nov 13, 2012 2:17pm EST

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Nov 13 - Fitch Ratings downgrades the following Eastside Union School
District (the district), California general obligation (GO) bonds:

--$6.8 million series 2002 and 2003 to 'A-' from 'A'.

The Rating Outlook is revised to Stable.

SECURITY

The bonds are secured by unlimited ad valorem property taxes on property within 
the district.

KEY RATING DRIVERS

ONGOING GENERAL FUND BALANCE DECLINE: The rating downgrade to 'A-' from 'A' 
reflects the significant erosion of the district's unrestricted general fund 
balance in fiscal years 2011-2013, within the context of a weak local economy, 
limited tax base, dependence on volatile state funding, and policymakers' 
reluctance to fully align expenditures with revenues.

POTENTIALLY INSUFFICIENT FINANCIAL CUSHION: The district's reliance on state 
funding, its poor liquidity, and its limited local economic resources indicate 
the need for higher general fund balances than the 3.3% unrestricted general 
fund balance projected for fiscal 2013 year-end. Improved unrestricted general 
fund balances in fiscal years 2014 and 2015 are possible given the passage of 
Proposition 30 (absent further state funding volatility) but will still require 
the district to exhibit significant expenditure control.

DISTRICT HAS CONSIDERABLE EXPENDITURE REDUCTION OPTIONS: While policymakers have
demonstrated little willingness to make difficult expenditure cuts to date, 
their reluctance to do so has left them with a variety of available options for 
permanent expenditure reductions.

MANAGEABLE DEBT PROFILE: The district's dependence on volatile state funding is 
somewhat offset by a sparing use of debt, manageable pension and OPEB 
liabilities, and slowly growing student enrolment.

WEAK LOCAL ECONOMY: The local economy is characterized by high unemployment, low
wealth levels, and a limited tax base which is finally stabilizing after three 
years of significant taxable assessed valuation (TAV) declines.

CREDIT PROFILE

WEAKENED FINANCIAL POSITION

The district's finances have been pressured by reductions in state funding, upon
which it is heavily dependent, and policymakers' reluctance to reduce ongoing 
expenditures. The district entered the recession with a sizable financial 
cushion and maintained healthy reserves through fiscal 2011 due to federal 
stimulus dollars and state funding flexibility. However, the district has failed
to reduce ongoing expenditures to match reduced ongoing revenues. As a result, 
the district ended fiscal 2011 with a net deficit after transfers of $1.2 
million, expects to end fiscal 2012 with a net deficit of $1.6 million, and 
budgets to end fiscal 2013 with a further net deficit of $0.8 million.

Despite the net deficit in fiscal 2011, the district ended that year with a 
healthy unrestricted general fund balance of $3 million or 11.7% of spending. 
Unaudited fiscal 2012 results indicate a significantly reduced unrestricted 
general fund balance of $1.7 million or 6.3% of spending. This level of decline 
is in line with Fitch's expectations at the time of its December 2011 review. 
Imbalanced operations in fiscal 2013 are likely to result in a year-end 
unrestricted general fund balance of only $801,000 or 3.3% of spending. While 
this slightly exceeds the state's 3% general fund balance requirement, it 
represents a significant erosion of financial flexibility.

The passage of Proposition 30 which seeks to protect state funding for education
could significantly improve the district's unrestricted general fund position in
fiscal years 2014 and 2015 by restoring $441 per student (approximately 
$1.5-$1.6 million). Improved unrestricted general fund balances assume, however,
no further deterioration in the state's ability to fund school districts, 
realization of the district's student enrolment growth projections, continuation
of the seven furlough days and pay cuts implemented in May, and greater 
expenditure control.

Fitch considers that the district's reliance on state funding and its limited 
local economic resources necessitate higher general fund balances than might 
otherwise be necessary for the 'A' rating category. Low wealth levels and 
California's restrictive legal framework severely limit the district's revenue 
raising options. Given the paucity of permanent expenditure cuts made to date, 
Fitch believes the district has adequate financial flexibility to balance 
future-year budgets if policymakers choose to do so. Options include: increasing
the number of furlough days; reducing instructional days; increasing class 
sizes; implementing further pay cuts; and reducing number of senior 
administrative positions.

The district's current year labor contracts contain some rigidities such as: no 
salary reopeners; no ability to unilaterally suspend or eliminate contracted 
salary and wage increases; and guaranteed step and lane increases. However, they
do not contain required out-year payments, no-layoff or no-furlough provisions, 
binding arbitration requirements, or mandatory consideration of regional 
compensation in salary and wage adjustments.

The district's liquidity is highly constrained. The district advises that there 
is no financial flexibility from outside the general fund and it will be relying
on cross-year TRANs issuances, state revenue deferral exemptions (to be 
requested), and temporary cash advances from Los Angeles County (also to be 
requested) for general fund liquidity. During the balance of fiscal 2013, the 
district anticipates issuing $4.6 million in TRANs (18.9% of budgeted fiscal 
2013 expenditures) to be repaid in early fiscal 2014.

MANAGEABLE DEBT PROFILE

The district's debt burden is low, partially offsetting concerns about its 
economy and tax base. Data on overlapping debt are not available, but direct 
debt as a percentage of TAV is a very low 0.8% or $467 per capita. Based on 
historical data, Fitch estimates that overall debt is also a low burden. Debt 
amortization is rapid with approximately 72% of debt repaid over the next ten 
years. The majority of the district's direct debt is in the form of general 
obligation bonds secured by unlimited ad valorem property taxes and, therefore, 
somewhat protected against the district's worsening general fund performance. 
The district's total carrying costs for debt service, pension contribution, and 
other post-employment benefits were a relatively low 9.8% of its unaudited 
fiscal 2012 general fund and debt service fund revenues.

The district has no further debt issuance plans. Due to low income levels and 
TAV erosion, the district qualifies for hardship funding from the state to fund 
capital improvements. This has allowed the district to construct a fifth new 
elementary school due for completion in mid-2013 at a cost of $22.2 million. 
However, since the district has insufficient funds to operate another school, 
the new school facilities are likely to be mothballed until student enrolment 
growth generates sufficient operations and maintenance funding.

VERY LIMITED LOCAL ECONOMY

The district serves approximately 3,270 students in grades K-8 in northern Los 
Angeles County. The district's population is approximately 24,000 and it 
includes unincorporated rural areas of the county and a portion of the city of 
Lancaster.

Lancaster's unemployment was well above state and national averages at 15.7% in 
August, and employment continues to decline. The district's socio-economic 
characteristics remain well below state and national levels. The housing 
downturn has hit the region particularly hard; TAV has fallen 25.5% over the 
least three fiscal years (2010 to 2012). However, since TAV increased by 2.4% in
fiscal 2013 and some limited residential development is underway, the district's
property market appears to have bottomed out.

Fitch Ratings downgrades the following 
Eastside Union School District (the district), California general obligation 
(GO) bonds:

--$6.8 million series 2002 and 2003 to 'A-' from 'A'.

The Rating Outlook is revised to Stable.

SECURITY

The bonds are secured by unlimited ad valorem property taxes on property within 
the district.

KEY RATING DRIVERS

ONGOING GENERAL FUND BALANCE DECLINE: The rating downgrade to 'A-' from 'A' 
reflects the significant erosion of the district's unrestricted general fund 
balance in fiscal years 2011-2013, within the context of a weak local economy, 
limited tax base, dependence on volatile state funding, and policymakers' 
reluctance to fully align expenditures with revenues.

POTENTIALLY INSUFFICIENT FINANCIAL CUSHION: The district's reliance on state 
funding, its poor liquidity, and its limited local economic resources indicate 
the need for higher general fund balances than the 3.3% unrestricted general 
fund balance projected for fiscal 2013 year-end. Improved unrestricted general 
fund balances in fiscal years 2014 and 2015 are possible given the passage of 
Proposition 30 (absent further state funding volatility) but will still require 
the district to exhibit significant expenditure control.

DISTRICT HAS CONSIDERABLE EXPENDITURE REDUCTION OPTIONS: While policymakers have
demonstrated little willingness to make difficult expenditure cuts to date, 
their reluctance to do so has left them with a variety of available options for 
permanent expenditure reductions.

MANAGEABLE DEBT PROFILE: The district's dependence on volatile state funding is 
somewhat offset by a sparing use of debt, manageable pension and OPEB 
liabilities, and slowly growing student enrolment.

WEAK LOCAL ECONOMY: The local economy is characterized by high unemployment, low
wealth levels, and a limited tax base which is finally stabilizing after three 
years of significant taxable assessed valuation (TAV) declines.

CREDIT PROFILE

WEAKENED FINANCIAL POSITION

The district's finances have been pressured by reductions in state funding, upon
which it is heavily dependent, and policymakers' reluctance to reduce ongoing 
expenditures. The district entered the recession with a sizable financial 
cushion and maintained healthy reserves through fiscal 2011 due to federal 
stimulus dollars and state funding flexibility. However, the district has failed
to reduce ongoing expenditures to match reduced ongoing revenues. As a result, 
the district ended fiscal 2011 with a net deficit after transfers of $1.2 
million, expects to end fiscal 2012 with a net deficit of $1.6 million, and 
budgets to end fiscal 2013 with a further net deficit of $0.8 million.

Despite the net deficit in fiscal 2011, the district ended that year with a 
healthy unrestricted general fund balance of $3 million or 11.7% of spending. 
Unaudited fiscal 2012 results indicate a significantly reduced unrestricted 
general fund balance of $1.7 million or 6.3% of spending. This level of decline 
is in line with Fitch's expectations at the time of its December 2011 review. 
Imbalanced operations in fiscal 2013 are likely to result in a year-end 
unrestricted general fund balance of only $801,000 or 3.3% of spending. While 
this slightly exceeds the state's 3% general fund balance requirement, it 
represents a significant erosion of financial flexibility.

The passage of Proposition 30 which seeks to protect state funding for education
could significantly improve the district's unrestricted general fund position in
fiscal years 2014 and 2015 by restoring $441 per student (approximately 
$1.5-$1.6 million). Improved unrestricted general fund balances assume, however,
no further deterioration in the state's ability to fund school districts, 
realization of the district's student enrolment growth projections, continuation
of the seven furlough days and pay cuts implemented in May, and greater 
expenditure control.

Fitch considers that the district's reliance on state funding and its limited 
local economic resources necessitate higher general fund balances than might 
otherwise be necessary for the 'A' rating category. Low wealth levels and 
California's restrictive legal framework severely limit the district's revenue 
raising options. Given the paucity of permanent expenditure cuts made to date, 
Fitch believes the district has adequate financial flexibility to balance 
future-year budgets if policymakers choose to do so. Options include: increasing
the number of furlough days; reducing instructional days; increasing class 
sizes; implementing further pay cuts; and reducing number of senior 
administrative positions.

The district's current year labor contracts contain some rigidities such as: no 
salary reopeners; no ability to unilaterally suspend or eliminate contracted 
salary and wage increases; and guaranteed step and lane increases. However, they
do not contain required out-year payments, no-layoff or no-furlough provisions, 
binding arbitration requirements, or mandatory consideration of regional 
compensation in salary and wage adjustments.

The district's liquidity is highly constrained. The district advises that there 
is no financial flexibility from outside the general fund and it will be relying
on cross-year TRANs issuances, state revenue deferral exemptions (to be 
requested), and temporary cash advances from Los Angeles County (also to be 
requested) for general fund liquidity. During the balance of fiscal 2013, the 
district anticipates issuing $4.6 million in TRANs (18.9% of budgeted fiscal 
2013 expenditures) to be repaid in early fiscal 2014.

MANAGEABLE DEBT PROFILE

The district's debt burden is low, partially offsetting concerns about its 
economy and tax base. Data on overlapping debt are not available, but direct 
debt as a percentage of TAV is a very low 0.8% or $467 per capita. Based on 
historical data, Fitch estimates that overall debt is also a low burden. Debt 
amortization is rapid with approximately 72% of debt repaid over the next ten 
years. The majority of the district's direct debt is in the form of general 
obligation bonds secured by unlimited ad valorem property taxes and, therefore, 
somewhat protected against the district's worsening general fund performance. 
The district's total carrying costs for debt service, pension contribution, and 
other post-employment benefits were a relatively low 9.8% of its unaudited 
fiscal 2012 general fund and debt service fund revenues.

The district has no further debt issuance plans. Due to low income levels and 
TAV erosion, the district qualifies for hardship funding from the state to fund 
capital improvements. This has allowed the district to construct a fifth new 
elementary school due for completion in mid-2013 at a cost of $22.2 million. 
However, since the district has insufficient funds to operate another school, 
the new school facilities are likely to be mothballed until student enrolment 
growth generates sufficient operations and maintenance funding.

VERY LIMITED LOCAL ECONOMY

The district serves approximately 3,270 students in grades K-8 in northern Los 
Angeles County. The district's population is approximately 24,000 and it 
includes unincorporated rural areas of the county and a portion of the city of 
Lancaster.

Lancaster's unemployment was well above state and national averages at 15.7% in 
August, and employment continues to decline. The district's socio-economic 
characteristics remain well below state and national levels. The housing 
downturn has hit the region particularly hard; TAV has fallen 25.5% over the 
least three fiscal years (2010 to 2012). However, since TAV increased by 2.4% in
fiscal 2013 and some limited residential development is underway, the district's
property market appears to have bottomed out.
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