Feb 15 - Fitch Ratings affirms its 'AA' rating on the following Long Beach Unified School District, California (the district) debt: --$545.6 million general obligation (GO) bonds. The Rating Outlook is Stable. SECURITY The bonds are secured by an unlimited ad valorem property tax on all taxable property within the district. KEY RATING DRIVERS SOUND FINANCIAL PERFORMANCE: The district has built solid general fund reserves during a difficult period of state education funding cuts. STRONG FINANCIAL MANAGEMENT: Elected officials' willingness to make difficult spending reductions, professionalized management, and a thorough oversight and financial reporting framework create a strong basic foundation for district performance and the credit rating. STATE DEPENDENCE: The district's dependence on the state of California for funding requires careful management of significant revenue volatility and payment deferrals. LARGE, DIVERSE ECONOMY: The local economy is large and diverse, and centrally located in the greater Los Angeles metropolitan area. Socioeconomic indicators are mixed, but the economy is fundamentally sound. STABLE TAX BASE: The expansive and well-established local tax base suffered very manageable declines during the national housing downturn, and assessed value (AV) has grown for the past two years. MIXED DEBT PROFILE: The district's debt profile is mixed, characterized by a moderate overall debt burden and strong community support for its GO bond program, balanced against large deferred capital needs and significant pension and other post-employment benefit (OPEB) liabilities. RATING SENSITIVITY FAILURE TO MAINTAIN RESERVES: A failure to resolve the district's remaining structural budget imbalance or a significant decline in reserves from the current level would put downward pressure on the rating. CREDIT PROFILE Long Beach USD is California's third-largest school district, serving about 79,000 students and 515,000 residents. It includes 129 square miles of southeastern Los Angeles County, including the cities of Long Beach, Signal Hill, Santa Catalina Island, much of the city of Lakewood and a portion of unincorporated Los Angeles County. The district operates 83 schools. SOLID FINANCIAL PERFORMANCE The district has managed well through a period of financial and economic stress that continues to force significant expenditure reductions. The district is largely dependent on the state of California for funding, which declined significantly with the recession and has only recently shown signs of improving. State funding declines stem from both state spending reductions and declines in district enrollment, which has been dropping for most of the past decade. Given very limited local revenue raising flexibility due to state law, the district has reacted to revenue declines with expenditure reductions. It made significant operating expenditure cuts that totaled 13.7% over the four fiscal years ended 2012. The cuts included politically difficult school closures and deep cuts in teaching staff, with positions reduced by 21% since 2008. Management has identified $14 million of $20 million in cuts it expects to make fiscal 2014. The district appears to have adequate expenditure flexibility to address a remaining structural budget imbalance (after the planned cuts) of about $10 million to $15 million. The district has excess school capacity due to declining enrollment, and the school year is five days longer than the minimum required by the state. However, expenditure flexibility has undoubtedly diminished significantly. RESERVES SOLID, BUT MAY DECLINE Financial reserves are solid. The district's unrestricted general fund balance was $94.8 million, or 13.8% of expenditures at the end of fiscal 2012. The district built reserves across the recession by combining categorical spending flexibility and short-term aid from the federal government with meaningful cuts in in ongoing spending. Even with improved fund balances, the district needed cash flow borrowing for the first time in many years in 2013, issuing $75 million of inter-year tax and revenue anticipation notes to manage state funding deferrals. Historically, the district maintained narrow unreserved fund balances of about 4% to 8% of spending. The district's very strong expenditure discipline largely offset concerns about fund balances levels. With expenditure flexibility significantly reduced and liquidity needs increased, Fitch no longer believes spending discipline alone can offset the risk of low reserves. The district plans to spend some reserves as it gradually closes its remaining structural budget imbalance over the next few years, but it is unclear how far reserves will fall due to uncertainty about state funding. Indeed, planned cuts would be sufficient to return the district to a balanced budget next year if the governor's budget blueprint were adopted with proposed increases in state funding. But with a status quo funding formula, the district would see continued pressure on its reserve position. The rating would likely be downgraded if the district reduces reserves to their former range. DIVERSE, SOLID ECONOMY The economy is large and diverse. The district's assessed value (AV) is $51 billion, or a solid $99,000 per capita. The housing market decline of recent years was somewhat muted in Long Beach because it is a built-out, established coastal community. AV declined a manageable 2.9% in 2009 and 2.4% in 2010 but has since increased by 1.1% in 2012 and 2.6% in 2013. The level of 2013 AV is just 1.8% below its peak in 2009. The district's tax base is a diverse mix of residential, commercial and industrial properties, and concentration is low with the top 10 taxpayers accounting for 9% of AV. While the district benefits from its position at the heart of the massive Los Angeles metropolitan area economy, the district's economy is large and reasonably diverse in its own right. The Long Beach economy is heavily influenced by the cyclical trade, manufacturing and tourism industries, with some stability provided by large healthcare, education and government employers. The Boeing Co. (Issuer Default Rating 'A'/Stable Outlook) is the largest private sector employer, and the Port of Long Beach (rated 'AA'/Stable Outlook) is the nation's second-largest container port. The city's unemployment rate remained elevated at 11.2% in December 2012. The non-seasonally adjusted jobless rate was down by almost two percentage points over the past year but remained above both state (9.7%) and national (8.1%) rates. The urban, blue collar community's socioeconomic indicators are mixed. School district median household income is slightly higher than the national median at about $55,400, but just 90% of the state median income. The poverty rate is above average at 17.9%, versus 14.3% for the nation. MODERATE DEBT BURDEN The district's debt burden is moderate with direct and overlapping debt equal to a moderate 2.7% of AV. The district relies on fixed-rate GO bonds to meet almost all of its capital needs. Amortization is moderate with 44% of principal repaid in 10 years. The district has considerable capital needs. Much of its physical plant was built before 1960 and will need to be updated, but the district faces no growth pressures and enjoys considerable flexibility in the timing of projects and bond issuance. District voters approved $1.2 billion of GO bonds in 2008, and the district plans to use its remaining $864 million authorization to update its physical plant gradually over the coming years. Fitch expects the district's debt burden to remain quite manageable, as the district phases projects to minimize impact on tax rates. Long Beach USD plans to return to market with another $50 million of GO bonds later this year. SIGNIFICANT, RISING POST-EMPLOYMENT LIABILITIES Post-employment liabilities are significant and likely to pose an increasing burden on the district in the years ahead. The district participates in the poorly funded CalSTRS pension system for teachers, as do all schools in the state. CalSTRS 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. Statutorily required contributions are substantially below the level required to amortize existing obligations. It is unclear which stakeholders would face increased contribution rates, and how such increases would be implemented, but Fitch believes districts would likely bear at least part of the burden. The district's unfunded other post-employment benefit liabilities are significant at $329.4 million, or 0.7% of market value, though recent changes in health care offerings will limit the growth in health care spending and reduce the liability somewhat. In total, the carrying costs of debt service, pensions and OPEB equaled a manageable 12.2% of governmental funds spending, less capital projects, in fiscal 2012.