Fitch Rates Evergreen School District, CA Unlimited Tax GO Bonds 'AAA'; Outlook Stable

Fitch Ratings has assigned an 'AAA' rating to the following Evergreen School District (CA) (the district) bonds:

--$50 million general obligation (GO) bonds (election of 2014), series 2016.

The bonds are expected to be sold via negotiation on Feb. 17, 2016. Proceeds will be used to construct and modernize district facilities.

Fitch also assigns an Issuer Default Rating (IDR) of 'A+' to the district.

The Rating Outlook is Stable.

On Sept. 10, 2015, Fitch published an exposure draft of revised state and local government tax-supported criteria. Fitch expects that final criteria will be approved and published in the first quarter of 2016. Pursuant to Fitch policy, new rating assignments during a criteria exposure draft period, while the prior criteria are still outstanding, must be analyzed under both criteria approaches. If there is a difference in the rating under the two criteria, then the proposed criteria are used because they more accurately reflect Fitch's current view.

In this case, while there is no rating difference on the ULTGO bonds, the assigned IDR is based on the exposure draft criteria, as the IDR under the current criteria would be higher. The IDR reflects the district's relative vulnerability to default on its financial obligations. The difference reflects the lesser weight given by the proposed criteria to school districts' local economies and tax bases and the greater weight placed on school districts' revenue framework. In particular, the district's state-determined revenues are closely tied to its declining student enrollment and the district's independent ability to raise revenues is very limited.

SECURITY

The bonds are secured by an unlimited ad valorem property taxes levied on all taxable property in the district.

KEY RATING DRIVERS - SPECIAL REVENUES

SPECIAL REVENUE: Fitch has been provided with legal opinions indicating that the tax revenues levied to repay the bonds would be considered 'special revenues' in the event of a district bankruptcy. Fitch concurs with the legal analysis outlined in the opinions. The 'AAA' GO bond rating is based on a special tax analysis without regard to the district's financial operations.

STRONG DEDICATED REVENUE STREAM: The district is an integral part of the strong Silicon Valley employment market, with above-average socioeconomic characteristics and a strong, diverse property market. Consequently, Fitch expects the property tax revenues dedicated to GO bond repayment to continue benefitting from positive economic growth within the district.

KEY RATING DRIVERS - IDR

LIMITED OPERATIONAL REVENUE FRAMEWORK ('bbb' key rating factor assessment): While the district is currently benefitting from improved state funding for education, its declining student enrollment and relatively low number of targeted students will reduce its proportionate share. The district has very limited legal ability to raise revenues independently.

USEFUL EXPENDITURE FLEXIBILITY ('aa' key rating factor assessment): During the recession the district demonstrated its willingness to use significant expenditure controls which it retains, despite labor agreements' binding arbitration requirements. However, recent expenditure increases have outpaced the recent improvement in state funding. Currently affordable carrying costs will rise due to mandatory pension contribution increases.

MODERATE LONG-TERM LIABILITY BURDEN ('aa' key rating factor assessment): The district's debt burden is moderate although it will increase due to new bond issuance. Pension liabilities are fairly low.

RESERVES BEING CHALLENGED BY DECLINING ENROLLMENT ('a' key rating factor assessment): The district's current financial position is satisfactory relative to budgetary flexibility; however, sustained declining student enrollment is creating fiscal challenges as enrollment drives a large portion of revenues.

RATING SENSITIVITIES

STABLE TAX BASE: The 'AAA' GO bond rating is sensitive to material negative changes in the district's tax base and economy, which Fitch considers are unlikely.

IDR SENSITIVE TO FINANCIAL PERFORMANCE: The 'A+' IDR is sensitive to the district's ability to close the structural budget gap and maintain satisfactory reserves through spending cuts if revenues do not rise sufficiently.

CREDIT PROFILE

The 32-square mile district is located in San Jose and serves an estimated population of approximately 108,000. It operates 15 elementary schools and three middle schools. On average, approximately 12,200 students attend the district daily.

TAX REVENUE TO REPAY BONDS VIEWED AS 'SPECIAL REVENUES'

Under the U.S. bankruptcy code, special revenues would not be subject to the automatic stay (i.e. repayment interruption) in the event the district was to file for bankruptcy.

Fitch has reviewed and analyzed legal opinions provided by counsel for the district opining that, pursuant to certain state constitutional provisions, the pledged property tax revenues dedicated for bond repayment are expected to be treated as special revenues in the event of a district bankruptcy.

As a result, Fitch analyzes these bonds as special tax bonds. This analysis focused on the district's economy and its debt burden, without regard to the district IDR.

STRONG DEDICATED REVENUE STREAM

The district is an integral part of the strong Silicon Valley employment market, enjoying above-average socioeconomic characteristics. The district's tax base experienced only two years of assessed valuation (AV) losses in fiscals 2010 and 2011, followed by very strong 21.9% AV growth through fiscal 2016. There is significant potential for AV growth from housing turnover within the district, since approximately two-thirds of single family residences are assessed at or below the city of San Jose's 2015 median sale price of $708,500.

The potential for new construction is somewhat limited, largely focused on residential in-fill. However, there is an 85-acre property which is slated for a mixture of residential and retail construction. It is hoped that the new residences will generate approximately 150 students for the district.

The district's tax base is diverse. The top 10 taxpayers represent only 2.9% of its fiscal 2016 AV.

MODERATE DEBT BURDEN

Overall debt is above average on a per capita basis ($5,040). However, it is moderate relative to AV (3.4%). Amortization is moderate at approximately 50% in 10 years, with the accreted interest related to the district's limited use of capital appreciation bonds hardly affecting amortization speed.

The district has had a hiatus from issuing new debt since 2009 due to politically self-imposed tax rate constraints. The series 2016 bonds will be the first made under a $100 million 2014 GO bond measure approved by 67.5% of district voters. A second, smaller issuance is expected in two to three years, with a final issuance two to three years after that.

The district participates in two state-funded pension systems, both of which are mandating increasing employer contributions over the next few years to improve their funded ratios. At June 30, 2015, the district's proportionate share of CalSTRS' and CalPERS' net pension liabilities was $80.5 million (assuming 7.6% and 7.5% discount rates, respectively). Using Fitch's more conservative 7% discount rate, the district's proportionate share increases to $85.7 million or a low 0.6% of the district's fiscal 2015 AV. Combined debt and Fitch-adjusted pension costs were manageable at 16.7% of personal income in fiscal 2015.

The district provides relatively generous other post-employment benefits (OPEBs) to eligible employees and their spouses through age 65. There is an unfunded actuarially accrued liability of $40.1 million (July 2014 valuation). The district currently has $1.7 million held for future OPEB liabilities and is actively considering placing that into an irrevocable trust. The district aims to augment the money available for OPEB funding from one-time federal and state monies.

In fiscal 2015, the district's annual debt repayment, mandatory pension system contributions, and pay-as-you-go OPEB contributions amounted to an affordable 13.9% of total government spending. However, this will increase with the issuance of new debt and mandatory pension contribution increases.

RESERVES BEING CHALLENGED BY DECLINING ENROLLMENT

After three years of drawdowns, the general fund ended fiscal 2015 with a still satisfactory unrestricted general fund balance of $10.6 million or 9.8% of spending. However, this represents a significant decline from its peak unrestricted general fund balance of $22.5 million or 23.9% of spending in fiscal 2011. General fund liquidity has remained consistently strong, with no need for the district to issue TRANs since 2004.

The general fund's structural imbalance is projected to continue. It is expected to be masked in fiscal 2016 by $6.8 million in one-time mandated cost settlements from the state. However, the district's multiyear projections indicate a further two years of general fund drawdowns in fiscals 2017 and 2018 as costs continue to rise despite marked student enrollment decline. This decline is projected to persist for the next five years due to local demographic shifts (rising cost of housing, families ageing out of the elementary school district, and fewer babies having been born during the recession).

While the district has been benefitting from improvements in state funding for education under the local control funding formula (LCFF), it is not a recipient of concentration funding for targeted students. This is due to an unduplicated count of a relatively low 44% of its student body being English language learners, recipients of free or subsidized lunches, or in foster care. Consequently, over time, the district will receive proportionately less benefit from LCFF compared to districts with high unduplicated counts.

POINTS OF BUDGETARY FLEXIBILITY

Fitch notes that, during the recession, the district demonstrated its ability to make difficult resourcing decisions as it laid off employees for the first time, froze spending, and subsequently negotiated employee contributions towards health benefit costs. All of these options remain open to the district as it manages its expenditures in a falling student enrollment environment. However, they might prove harder to implement outside of a recession. In terms of personnel expenditures, the district is most likely to rely on expiring temporary positions, attrition, and managed hiring in the short- to medium-term.

The district enjoys strong taxpayer support. In addition to approving the 2014 GO bond measure, 74.9% of district voters approved a parcel tax renewal at an increased rate in 2014, and there are two foundations contributing support to the district. However, the district will have to navigate through contentious resource redistribution decisions as it addresses its demographic issues. Ten years ago, the district successfully worked through a controversial school boundary change process which suggests that it has the ability to work through its current issues.

The district is about to formally consider strengthening its financial management policies so that it moves toward an unrestricted general fund reserve of 15%, establishes an irrevocable OPEB trust, and restricts usage of one-time federal and state revenues for one-time purposes only. Strengthened financial management policies could help counterbalance expenditure pressure from sometimes contentious labor relations. Negotiations with the teachers' union are currently at impasse, although the classified labor union has settled at 3% for fiscal 2016. Binding arbitration requirements in the district's labor contracts have the potential to somewhat limit the district's personnel expenditure flexibility.

Additional information is available at 'www.fitchratings.com'.

Fitch recently published exposure drafts of state and local government tax-supported criteria (Exposure Draft: U.S. Tax-Supported Rating Criteria, dated Sept. 10, 2015 and

Exposure Draft: Incorporating Enhanced Recovery Prospects into U.S. Local Tax-Supported Ratings). The drafts include a number of proposed revisions to existing criteria. If applied in the proposed form, Fitch estimates the revised criteria would result in changes to less than 10% of existing tax-supported ratings. Fitch expects that final criteria will be approved and published in the first quarter of 2016. Once approved, the criteria will be applied immediately to any new issue and surveillance rating review. Fitch anticipates the criteria to be applied to all ratings that fall under the criteria within a 12-month period from the final approval date.

In addition to the sources of information identified in the applicable criteria specified below, this action was informed by information from CreditScope and Lumesis.

Applicable Criteria

Exposure Draft: Incorporating Enhanced Recovery Prospects into US Local Tax-Supported Ratings (pub. 02 Feb 2016)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=875108

Exposure Draft: U.S. Tax-Supported Rating Criteria (pub. 10 Sep 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869942

Tax-Supported Rating Criteria (pub. 14 Aug 2012)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

U.S. Local Government Tax-Supported Rating Criteria (pub. 14 Aug 2012)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=999336

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