Nov 20 - Fitch Ratings has affirmed William S. Hart Union High School District, California's (the district) general obligations bonds (GOs) as follows: --$91.7 million (2001 election) GOs series B at 'AA-'; --$80.8 million (2008 election) GOs series A at 'AA-'. The Rating Outlook has been revised to Positive from Stable. SECURITY The general obligation bonds are secured by an unlimited property tax levied on all taxable properties within the district. KEY RATING DRIVERS --SOUND FINANCIAL POSITION: The Positive Outlook reflects years of financial outperformance, resulting in four consecutive years of general fund operating surpluses and a solid unrestricted general fund balance. --SOME FINANCIAL VULNERABILITIES REMAIN: The district is exposed to various vulnerabilities, in spite of its currently sound financial position, that could pressure reserves over the coming years. These include a challenged state funding environment despite recent passage of Proposition 30, four years of enrollment losses, a material degree of charter school competition, and participation in the state-run CalSTRS pension plan, which has a low funded ratio. --SOLID LOCAL ECONOMY: Santa Clarita benefits from its location within the large and diverse Los Angeles employment market. Further, the local economy enjoys materially stronger income and unemployment levels than the state and the nation, and population growth historically has been rapid. --MIXED TAX BASE: The district's tax base is well diversified, but its assessed valuation (AV) has contracted in three of the past four years, reflective of substantial home price declines from the housing market's peak. Home values in 2012 have risen modestly, and developer fees are well above trough levels of fiscal 2009. However, it remains to be seen whether home values have entered the beginning of a longer-term recovery. --IMPROVED DEBT PROFILE: The district successfully retired its $41.5 million of GO bond anticipation notes (BANs) with GOs. The refunding was accomplished within the politically promised tax rate under the assumption of 4%-5% long-term annual AV growth, which Fitch views as somewhat aggressive. Future capital needs are significant and financing them may slow an already below average principal amortization rate, and likely will hike debt levels to moderate levels. What Could Trigger A Rating Change CONTINUED FINANCIAL OUTPERFORMANCE: The district will need to maintain a sound financial cushion and show a credible plan for balanced operations on a going forward basis to have its rating considered for an upgrade. MAINTAIN ADEQUATE DEBT PROFILE: An upgrade would also be conditional on the district's ability to complete its sizeable capital improvement plan without material deterioration of its debt profile. CREDIT PROFILE Located in the northwestern portion of Los Angeles County (the county), the district includes the city of Santa Clarita (the city) and nearby unincorporated parts of the county. Population growth had been very high until recent years, as real estate and economic weakness has weighed on new development. Recent data shows new construction activity is rebounding significantly from trough levels, suggesting population growth may also recover somewhat. STRONG LOCAL ECONOMY The district's economic profile is good overall, thought recent data has been mixed. Poverty rates are very low, and median household income levels are well above average at 158% and 169% of state and national levels, respectively. August unemployment measured just 6.9%, down from 8% the year prior. However, improvement was attributable to a drop in the employment participation rate, not improvement to the labor force, which contracted 0.2% year over year. The local tax base is well-diversified and assessed value (AV) growth had been strong until fiscal 2010 when the hard-hit local housing market resulted in two consecutive years of moderate AV decline. AV rose in fiscal 2012 by a slight 0.4%, but fell 1.7% in fiscal 2013, suggesting house prices have not yet demonstrated a convincing recovery despite a pick-up in new construction. SOUND FINANCIAL OPERATIONS SOMEWHAT OFFSET BY BUDGETED DEFICIT The district's financial operations have performed well over the past several years, but are moderately vulnerable to various pressures moving forward. Management prudently enacted significant expenditure reductions early in the downturn, thus allowing the district to grow its unrestricted general fund balance in each year from fiscal 2008 to 2012 (fiscal 2012 results are estimated and unaudited). Estimated fiscal 2012 results show break-even operations, with total and unrestricted fund balances at high levels of $42 million (24.2% of expenditures and transfers out) and $39.3 million (22.7%), respectively. General fund operations in fiscal 2013 are budgeted for a large $12.3 million operating deficit, which would lower the unrestricted fund balance to a still-sound $26.5 million (14.5%). This reduced level of financial cushion would continue to be consistent with the current rating level. However, there could be downward rating pressure if, in future years, funding levels remain weak and the district does not initiate sufficient expenditure reductions to regain structural balance, resulting in an inadequate financial cushion. Fitch does not anticipate this scenario based on the district's history of strong financial management, outperformance of budgetary expectations, and maintenance of high fund balances. In November voters approved Proposition 30, a tax hike measure that prevented automatic state funding reductions. The passage of Proposition 30 will not result in additional revenues compared to budget, as the budget already assumed trigger cuts would not be enacted. However, Fitch believes offsetting elements of budgetary conservatism will result in budgetary out-performance in fiscal 2013. OPERATIONAL PRESSURES MITIGATED BY STRONG MANAGEMENT PRACTICES The $12.3 million budgeted fund balance deficit in fiscal 2013 largely stems from the expiration of federal stimulus funding, step and column wage adjustments, the addition of nine positions, and increased benefit costs. Multi-year projections indicate similar operational deficits in fiscal years 2014 and 2015, though prior year projections have been similarly negative while actual financial performance has been positive. These operational pressures are mitigated by strong management practices. The district has a considerable amount of legal expenditure flexibility in addition to the district's history of conservative budgeting and positive operating results. Management has identified a list of potential cost reductions totaling $20.6 million (12% of fiscal 2012 revenues), should cost-cutting be necessitated in future years. DEBT PROFILE IMPROVED, ADEQUATE OVERALL The district's debt profile improved as the result of refunding a $41.5 million BAN with GOs that mature within 25 years and are funded at a tax rate below the politically promised $35 per $100,000 AV limit. However, staying under the tax rate promised will require 4%-5% average annual AV growth over the long term, which Fitch views as aggressive. Although this rate of increase is consistent with the area's long-term historical averages, recent performance has been notably weaker and AV gains tend to diminish as a community becomes increasingly built out. Tax rates will adjust to whatever level is necessary to pay GO debt service, however, Fitch would view negatively an increase of the rate to above the promised ceiling as it may suppress voters' appetite for future bond authorizations. Direct and overlapping debt levels are low to moderate at $3,318 per capita (2.6% of AV), but amortization is slower than average at 39.3% over 10 years. The district has a sizeable capital improvement plan, however, that likely will push debt to moderate levels, and could result in even slower amortization. The district is looking to modernize three schools, build a new high school, and construct two new auditoriums. To fund these costs, the district expects to issue $175 million over the next two years under separate issuances. These issuances are expected to exhaust the district's only two GO authorizations, Measures C and D. OPEB, PENSION COSTS CURRENTLY MANAGEABLE BUT LIKELY TO RISE The district's other post-employment benefit (OPEB) costs currently are manageable, but are likely to rise moving forward as the district funds OPEB on a pay-as-you-go basis. The unfunded liability currently is small at $66 million, or just 0.2% of AV. As with all California school districts, the district participates in the state-run CalSTRS pension plan for its teachers. Although the district is paying 100% of its required rate, in fiscal 2011 system contributions were equal to just 46.7% of the actuarially required rate. Contribution rates are set by statute and they have not been increased to reflect the weak investment return environment over the past several years. As a result, the system's Fitch-adjusted funded ratio has fallen to a low 65.7% and future contribution rates likely will need to rise substantially from current levels. It is unclear which stakeholders would face increased contribution rates, and how such increases would be implemented, but Fitch believes districts would be likely to bear at least part of the burden.