Jan 14 - Fitch Ratings has taken the following action on Banning Unified School District, California (the district): --$10.9 million general obligation (GO) bonds (election of 2002) series A and B affirmed at 'A+'; --$36.6 million GO bonds (election of 2006) series A and B affirmed at 'A+'. The Rating Outlook is Negative. SECURITY The bonds are secured by an unlimited ad valorem tax levied on all property subject to taxation in the district. KEY RATING DRIVERS WEAK FINANCIAL POSITION: Substantial and ongoing revenue declines have weakened the district's finances and outpaced efforts to reduce expenses. The Negative Outlook reflects the potential for further deterioration of the district's financial position if it is unable to restore structural balance. CHALLENGED ECONOMY: The district continues to suffer from high unemployment levels and a weak housing market. Most economic indicators have improved in the past year but remain well below pre-recession peaks. STEPS TOWARDS FISCAL RECOVERY: The district has recently developed a fiscal recovery plan intended to strengthen its finances and prevent further declines in reserve levels. Fitch views the creation of this plan as a credit positive, but many of its key components will not be implemented until the 2013-14 school year. REDUCED RISKS FROM STATE DISTRESS: The November 2012 approval of Proposition 30 by California voters (increasing income and sales taxes temporarily to fund education) removes the threat of mid-year funding cuts for the district. In addition, improved state finances appear likely to boost school funding in fiscal 2014 and help restore revenues that were deferred during the recent recession. WHAT COULD TRIGGER A RATING ACTION Ongoing deficits that reduce fund balance below state-required levels would increase downward pressure on the rating. CREDIT PROFILE Located in western Riverside County, 80 miles east of downtown Los Angeles, the district encompasses 300 square miles, including the City of Banning and portions of unincorporated Riverside County, including the Morongo Indian Reservation; the population is estimated at 34,000 residents. The district operates eight schools with total enrollment of approximately 5,000 students. CONTINUED ECONOMIC WEAKNESS The Banning economy has been slow to recover from the recent recession as employment and housing markets remain weak. Job growth has been steady since late 2009, but employment levels remain well below pre-recession peaks. Unemployment rates were elevated at 13.7% as of September 2012, a noted improvement from the September 2011 rate of 15.9%, but continue to exceed state and national averages by large margins. Wealth and income indicators for the district are below average at approximately 65% to 80% of state and national levels, respectively. The local housing market has shown signs of recovery recently, with a 5.5% year-over-year increase in home values as of November 2012. Such gains follow declines of more than 50% in home values countywide during the recent recession. Taxable assessed values (TAV) for the district have dropped nearly 20% during this period and have yet to resume growth. The top 10 taxpayers in the district account for 21% of TAV, a moderate level of concentration, but include a diverse mix of industrial and commercial properties. The district's economic challenges have also contributed to several consecutive years of enrollment declines, as families leave the district in search of better employment opportunities; students also reportedly have left to attend high school in a neighboring district that offers more extracurricular activities. Since most school revenues in California are allocated on a per-pupil basis, reduced enrollment has a direct impact on the district's finances. Enrollment levels appear to have stabilized in the current school year but remain at risk of further declines. FISCAL RECOVERY PLAN SEEKS TO STEM DEFICITS Declining state revenues have resulted in three consecutive years of deficits for the district, which has been unsuccessful in reducing expenditures to match decreased funding levels. Unrestricted general fund balance fell to 4.1% of spending at the end of fiscal 2012 and district management projects a further decline to 3.1% in 2013, which Fitch considers likely in the face of continued structural imbalance. Projections of ongoing deficits for fiscals 2014 and 2015 have prompted increased oversight of the district from the Riverside County Office of Education, including the development of a fiscal recovery plan. The chief component of this plan involves the repurposing of an existing elementary school to serve special education students and other student programs, allowing the district to reduce its expenditures for such services. The district is also seeking savings from personnel reductions and labor concessions to help balance its budget for the 2013-14 school year. REDUCED RISKS FROM STATE DISTRESS The district's efforts to achieve fiscal recovery will be aided by recent improvements in state funding prospects. The passage of Proposition 30 by state voters in November 2012 removes the threat of new cuts in the current fiscal year, and increased funding levels under Proposition 98 appear likely for fiscal 2014 and beyond. District finances will continue to be challenged despite these improvements, but risks related to the state's finances appear greatly reduced as compared to one year ago. MODERATE DEBT WITH SLOW AMORTIZATION Direct and overlapping debt levels for the district are moderate at 4.5% of TAV and amortization is below average with 27% of outstanding debt retired in 10 years. The district retains $2 million in proceeds from its 2006 issuance which are available to address immediate capital needs, but longer-term plans for construction of a new middle school and improvement of athletic facilities are constrained by tax rate limits applicable to new debt. The district participates in two state-sponsored employee pension plans and is likely to face increased contribution rates over the next several years to offset recent investment losses. OPEB costs are funded on a pay-as-you-go-basis, resulting in a growing liability for these commitments.