TEXT - Fitch rates Ohio's Cleveland Muni School District bonds

Fri Jan 4, 2013 2:11pm EST

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Jan 4 - Fitch Ratings has assigned the following program rating to Cleveland Municipal School District OH's (the district) unlimited tax general obligation (ULTGO) qualified school improvement refunding bonds: --$40,395,000, series 2013, 'AA'. In addition, Fitch assigns an underlying rating of 'A-' to the series 2013 bonds. The bonds are expected to sell via negotiated sale on Jan. 15, 2013. Proceeds are being used to refund outstanding series 2004 bonds. In addition, Fitch affirms the following ratings: --Outstanding GO bonds, series 2002, 2004, 2010, and 2011 underlying rating at 'A-'. The Rating Outlook is Stable for the program and underlying ratings. SECURITY The bonds are voted general obligations of the district secured by the district's unlimited ad valorem tax pledge. The Ohio School District Credit Enhancement Program requires the Ohio Department of Education (ODE) to forward state foundation program payments to the bond registrar if, prior to the bond payment date, the district has not transmitted funds sufficient to cover required debt service payments. KEY RATING DRIVERS EDUCATION REFORM LEGISLATION ENACTED: In July 2012, the Governor signed House Bill 525 known as the 'Cleveland Plan' (the plan). The legislation's goal is to improve educational standards, and it provides district management with increased flexibility in working with labor groups. PROPERTY TAX LEVY APPROVED: To support the plan, in November 2012, voters approved, by a strong margin, a new four-year 15 mill property tax levy. FINANCIAL PRESSURES EASE TEMPORARILY: The approval of the new tax levy relieves some budgetary pressures and provides the district with some financial flexibility. However, Fitch believes that the district will continue to struggle to build reserve levels to satisfactory levels. PROACTIVE MANAGEMENT: The district's experienced management team has taken aggressive steps to address its budget imbalance by successfully implementing sizeable spending reductions over the last few years. LARGE AND DIVERSE ECONOMY: Cleveland has successfully diversified its economy away from manufacturing to the more stable and strong health and education sectors. Additionally, the area is seeing some momentum due to several significant projects that are currently in progress. POOR SOCIOECONOMIC INDICATORS: Despite diversification, the city and the district continue to experience above average unemployment rates, tax base declines, poor property tax collection rates and declining population and enrolment. Income levels are well below average and poverty levels are more than double the state and nation. MANAGEABLE DEBT PROFILE: The district's debt profile is characterized by overall low to moderate debt ratios, above average principal amortization, and manageable future borrowing plans. STRONG PROGRAM ESSENTIALS: The bonds qualify for the Ohio School District Credit Enhancement Program, which is characterized by stringent requirements and strong program mechanics. WHAT COULD TRIGGER A RATING ACTION FAILURE OF CLEVELAND PLAN: Fitch believes the district's inability to meet specific measurable goals under the plan would most likely result in failure of voters to renew the property tax levy in four years, resulting in budgetary pressure and reduced financial flexibility. INABILITY TO BUILD RESERVE LEVELS: Management's ability to improve reserves to satisfactory levels in the medium term will be key to maintaining the rating at the current level. CREDIT PROFILE The Cleveland Municipal School District (CMSD) is located in Cuyahoga County in northeastern Ohio. Of the district's area of approximately 82 square miles, 99.3% is located within the City of Cleveland (the city; GO bonds rated 'A+' with a Stable Outlook by Fitch). District enrollment continues to decline due primarily to the declining city population, the expansion of charter and private schools, and weak academic performance. Enrollment for 2011-2012 totaled 40,782, a 45% decline since 2000-2001 and a 6.7% decline from 2010-2011. For the 2011-12 school year, the district was placed in 'Academic Emergency', a step below the 'Academic Watch' status it held in the 2010-11 school year and the lowest of five possible categories of academic achievement. Although district performance remained stable, the value added factor, which is a measure of student learning growth, resulted in the change in status. EDUCATION REFORM LEGISLATION RECENTLY ENACTED On June 12, 2012, the Ohio General Assembly passed legislation and on July 7, 2012, the Governor signed 'The Cleveland Plan'. The Cleveland Mayor, Governor Kasich, the General Assembly, the Cleveland Teacher's Union and the Cleveland business community collaborated to create a plan for education reform for the district to improve standards, reward, retain and recruit high-quality educators, increase incentives for district and charter school partnerships and increase school autonomy and accountability. The legislation gives the district greater flexibility and more authority in how teachers are evaluated and allows the district to intervene in lower performing schools, reassign teachers and require them to work more hours, outside of the confines of labor agreements. Additionally, the district has the legal authority, via agreements, to share state funds with high quality charter school partners. On an academic achievement basis, the district will be able to count charter school student test scores. The legislation is for six years with the plan being implemented over four years. The Cleveland Transformation Alliance has been created and is comprised of members of local government and the community to ensure accountability for all public schools in the city. The district will hold itself accountable to specific measurable goals including eliminating failing schools, increasing graduation rates substantially, increasing college enrolment moderately, and tripling the number of students enrolled in high performing schools. Fitch believes that the goals are somewhat aggressive but this legislation is generally positive. Combined with the approval of a new property tax levy, it gives the district some necessary tools for transformation and provides some financial relief. NEW PROPERTY TAX LEVY PROVIDES TEMPORARY RELIEF In November 2012, district voters passed by a strong margin (57%) a 15-mill property tax levy to support the plan and transformation efforts. The district's existing levy is 64.8 mills. Fourteen mills will be allocated to the district and one mill will be allocated to the partnering charter schools (11 currently). Based on reduced 2013 assessed value following a sexennial reassessment and current weak property tax collections, the levy is expected to generate $63 million annually for the district. Of this, $4.2 million will be distributed to charter school partners. The levy is for four years (through 2016) to provide for accountability, allowing voters to evaluate whether the district is succeeding and if tax dollars should continue. In November 2016, a Presidential election year, the district expects to position the levy as either a renewal of the 15 mills or a replacement levy, which if assessed values go up, would allow for an adjusted millage levy and additional dollars. Fitch views the approval of the tax levy positively despite being temporary, as it provides financial flexibility and shows strong community support for transformation. Historically, voter approval for new property tax levies has not been successful. The last property tax levy was passed in 1996, with subsequent levies in 2004 and 2005 failing with 45% and 35% voter approval, respectively. Bond issues have fared better with all being passed, the last one in 2001. On a positive note, all current property tax revenues, which represent 23% of total general fund revenue, are derived from non-expiring levies. WEAK FINANCIAL PROFILE WITH LOW RESERVE LEVELS The district's strong and experienced management team has taken aggressive steps to address its budget imbalance by successfully implementing sizeable spending reductions including the closing of schools, the elimination of teaching positions and labor union concessions. The district closed a $58 million (9.1% of spending) budget gap in 2011. For fiscal 2011 (year-end June 30), the district reported a general fund operating surplus after transfers of $37.7 million compared to a deficit of $37.8 million in 2010. The district reported an unrestricted general fund balance of $13 million or 2.2% of spending at June 30, 2011, compared to a negative unreserved (pre-GASB 54) fund balance of $41 million or negative 6.2% of spending at June 30, 2010. On an unaudited GAAP basis for 2012 the district recorded a general fund operating deficit after transfers of $6.4 million due primarily to lower revenues and higher instruction costs. The unrestricted general fund balance totaled $10.3 million or a weak 1.6% of spending. The October 2012 five-year (2013-2017) cash-basis forecast was revised in December to reflect the passage of the 15 mill property tax levy. The new levy provides some breathing room with general fund operations positive through 2014. Deficits of $10.8 million, $23.4 million and $65 million are forecasted for fiscal 2015, 2016 and 2017, respectively. Fiscal 2017 does not include the renewal/replacement of the 15 mill levy. For 2013 the general fund ending unencumbered cash balance is forecast at $41.3 million, up from $35.6 million in 2012 but decreasing to $11.2 million in 2016 and a negative $53.8 million in 2017. Fitch recognizes the conservative assumptions of the forecast. However, while the approval of the new tax levy relieves some budgetary pressures, Fitch believes that the long-term structural balance and the building of reserves to stronger levels will remain challenging. Concerns include the level of future state funding, which represents 69% of general fund revenues, decreasing assessed value and increasing property tax delinquencies. Cost containment, successful implementation of the transformation plan and continued community support remains essential to the district's financial health. DIVERSE ECONOMY BUT WEAK SOCIOECONOMIC INDICATORS While Cleveland's economy has successfully diversified away from manufacturing to the more stable health and education sectors, the city continues to feel the effect of the sluggish economy as evidenced by weak economic trends and indicators. The city continues to lose population, unemployment rates are above average, poverty rates are more than double the state and nation, income levels are well below average and property tax collections remain weak. On the plus side, economic development is strong with a number of major projects under construction including the $465 Medical Mart and Convention Center in downtown Cleveland which is scheduled to open in September 2013. MANAGEABLE DEBT POSITION The district's overall debt levels are moderate at 3.8% of market value or $1,540 per capita, and principal amortization is rapid with 84% of debt retired in 10 years. Debt service represents a moderate 7% of general and debt service fund expenditures. Future capital plans are manageable, with the district contemplating the issuance of $225 million in bonds in 2014 to fund the remaining three segments of its master facilities plan. The additional debt would more than double direct debt levels and will likely slow amortization considerably. The district contributes to the School Employees Retirement System and the State Teachers Retirement System, both multiple-employer defined pension plans. The District is required to make contributions in accordance with rates established by the state and has annually met the annual contribution, although this has not always equaled the actuarially required contribution (ARC). Contributions represented a moderate 8.2% of unaudited 2012 general fund spending. Total carrying costs for debt service, pension payment (which moderately underfunds the ARC) and OPEB costs are manageable at 15.7% of spending. STRONG PROGRAM ESSENTIALS The 'AA' program rating is based on the qualification of the series 2013 bonds for participation in the Ohio School District Credit Enhancement Program. Participation requirements are stringent, including 2.5 times coverage of maximum annual debt service by unrestricted state foundation aid on proposed bonds and any outstanding obligations covered by the program. Fiscal year 2013 estimated state foundation aid to the district is 14.2 times maximum annual debt service, well above the required 2.5 times. Program mechanics are strong. Ohio law requires the Ohio Department of Education (ODE) to forward to a bond paying agent or registrar state foundation payments otherwise due to a participating school district if, prior to the bond payment date, the district has not transmitted funds sufficient to cover a required debt payment. For more information on the Ohio School District Credit Enhancement Program, see Fitch's report dated May 13, 2011 at 'www.fitchratings.com'.

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