OREANDA-NEWS. Fitch Ratings has assigned a 'AAA' rating to the following Oakland Unified School District (the district) general obligation (GO) bonds:

--$65 million GO bonds (election of 2006), series 2016A;

--$161.55 million 2016 GO refunding bonds.

In addition, Fitch has assigned a 'BBB+' Issuer Default Rating (IDR) to the district.

The Rating Outlook is Stable.

SECURITY

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

KEY RATING DRIVERS

SPECIAL REVENUE ANALYSIS: The 'AAA' rating on the 2016 unlimited tax general obligation bonds is based on a dedicated tax analysis without regard to the district's financial operations. Fitch has been provided with legal opinions by district counsel that provide a reasonable basis for concluding that the tax revenues levied to repay the bonds would be considered 'pledged special revenues' in the event of a district bankruptcy.

GROWING TAX BASE; AFFORDABLE DEBT: The economic resource base supporting the GOs is strong, diverse and growing. The unlimited nature of the tax offsets any concern about tax base volatility. Overall debt is affordable relative to the tax base.

RATING SENSITIVITIES

Tax Base Drives GO Rating: The 2016 GO bond rating could come under downward pressure if the district experienced a significant and long-lasting decline in economic activity and property values, which Fitch believes is unlikely.

CREDIT PROFILE

The district is almost coterminous with the city of Oakland, located on the eastern shore of the San Francisco Bay. Like most California school districts, the bulk of Oakland USD's operational revenues are derived from a state-determined per pupil funding formula, though capital funding is largely locally funded. The district's tax base growth has been strong and steady except for two small declines during the Great Recession. Unemployment is somewhat elevated, but income levels are about average.

Tax Revenue to Repay Bonds Viewed as Pledged Special Revenues

Fitch believes that taxes levied for bond repayment would be considered pledged special revenues under the U. S. bankruptcy code, and therefore the lien on pledged revenues would survive and would not be subject to the automatic stay (i. e. payment interruption) in the event the district were to file for bankruptcy. Fitch has reviewed and analyzed legal opinions provided by district counsel and believes they provide a reasonable basis to conclude that these revenues would be treated as pledged special revenues due to certain provisions of the state constitution (primarily proposition 13), which limit and direct the use of pledged property tax revenues for bond repayment.

As a result, Fitch analyzes these bonds as dedicated tax bonds. This analysis focuses on the district's economy, tax base and debt burden without regard to financial operations because Fitch believes that bondholders are insulated from any operating risk of the district. Fitch typically calculates the ratio of available revenues to debt service for dedicated tax bonds, but the unlimited nature of the tax rate pledge on the district's bonds eliminates the need for such calculations.

The $47 billion tax base provides strong fundamental support for the 'AAA' 2016 GO rating. Concentration is low with the top 10 taxpayers (various commercial and industrial properties) accounting for less than 5% of AV. The tax base suffered minor declines in the Great Recession with a cumulative decline of 6.2% and a worst year of 3.2%. The tax base is again growing at a healthy pace, gaining 9.5% in fiscal 2016.

IDR Expands Analysis to Include Operating Performance and Framework

The 'BBB+' IDR reflects the district's limited gap closing capacity with low reserves relative to historical revenue volatility. The rating also reflects the district's weak revenue framework with slow historical revenue growth and no independent legal ability to raise revenues without a vote of the people. These weaknesses are partially offset by the district's moderate long-term liability burden, solid expenditure flexibility and the stabilizing influence of state fiscal oversight.

Economic Resource Base

The district is almost coterminous with the city of Oakland, located on the eastern shore of the San Francisco Bay. Like most California school districts, the bulk of Oakland USD's operational revenues are derived from a state-determined per pupil funding formula, though capital is largely locally funded. The district's tax base growth has been strong and steady except for two small declines during the Great Recession. Unemployment is somewhat elevated, but income levels are about average.

Revenue Framework: 'bbb' factor assessment

District revenues have been somewhat stagnant historically due to declining enrollment and the state's volatile revenue history. Revenues have recently rebounded due to both state economic improvement and enrollment gains, but the district's legal ability to raise revenues is constrained by Proposition 13, which requires voter approval for tax increases.

Expenditure Framework: 'aa' factor assessment

The district has a moderate fixed cost burden and solid flexibility to adjust spending. On average, growth in spending is likely to be in line with revenue growth over time.

Long-Term Liability Burden: 'aa' factor assessment

The long-term liability burden is moderate relative to the large economic resource base. The district participates in two adequately funded state-run pension plans and funds the bulk of its capital needs from voter-approved property tax levies.

Operating Performance: 'bbb' factor assessment

The district maintains relatively low available fund balances which, along with some expenditure flexibility, provide the district with a limited financial cushion relative to its expected revenue volatility. Budget management is generally supported by the state's strong school oversight regime; however, the district is still addressing several material weaknesses cited in recent audits.

Revenue Framework

State aid and local property taxes provide the majority of district operating revenues and are supplemented by local parcel taxes. State aid has been expanding due to improvements in the state's economy, recent enrollment gains and a new funding formula (LCFF) which provides additional funding for targeted students. The district benefits from two voter approved parcel tax measures. One generates about $12 million (2.3% of fiscal 2017 budgeted revenues) annually and sunsets in 2025. The other generates approximately $20 million (3.8%) annually and does not expire. Parcel taxes have experienced strong support from district residents, with over 70% approval rate.

Historical revenue growth has been very slow, well under CPI and U. S. GDP. The district experienced declining enrollment for several years through fiscal 2013 exacerbating an already challenged state funding environment. Prospects for future revenue growth will be largely driven by future enrollment trends and to a lesser extent by state revenue growth. Enrollment has been increasing since fiscal 2014 and the district projects modest increases as part of its multiyear forecast (through fiscal 2019). However, enrollment is difficult to forecast in an urban district with competition from both charter and private schools. Fitch will monitor the district's ability to attract and maintain its student population and related revenue.

State law requires voter approval of tax increases, limiting the ability of the district to control revenues. However, as noted, the district has had success in passing parcel taxes which supplement LCFF revenue.

Expenditure Framework

Personnel costs for teachers and staff comprise the vast majority of district expenditures. Fitch expects expenditure growth to be in line with to moderately above expected revenue growth based on the district's current labor contracts. The three-year contracts through fiscal 2017 provide that 65% of gains in unrestricted funding are provided as part of total compensation increases (including pension and health care costs). Ongoing LCFF funding gains are distributed as salary, pension and health insurance costs and one-time unrestricted funds are distributed as a one-time bonus. Fitch expects future contracts to be similarly structured, and such an arrangement should keep the district's expenditures closely aligned with revenues regardless of the pace of revenue growth. The district has never provided other post-employment benefits, avoiding a typical cost pressure.

The district's mandate to provide educational services places some limitations on its ability to make expenditure reductions in the event of a revenue decline. Nonetheless, the district's moderate carrying costs and ability to raise class sizes, consolidate schools, reduce elective offerings in middle school, make changes to the health benefits, and reduce funding for optional programs such as teacher recruitment; teacher development, library aides and music teachers provide solid expenditure flexibility.

Long-Term Liability Burden

The district's long-term liability burden (overall debt plus unfunded pension liabilities) are moderate relative to its resource base at about 14% of personal income. The district's debt issuance is funded from an unlimited property tax levy restricted to this purpose. The district expects to issue its remaining $175 million in authorization of new GO debt in 2018, which should not materially impact moderate overall debt ratios. Amortization of GO debt is slow, with 35% scheduled for retirement in 10 years. In addition to GO debt, the district has $48 million remaining on a $100 million emergency state loan received in 2003. The final payment is due June 2026. State pensions in which the district participates are adequately funded and reforms adopted in 2012 should slow the growth in the liability over time. Actuarial assumptions for the district's pensions are standard.

Operating Performance

Gap closing capacity is limited due to low reserve levels relative to historical revenue volatility. The district's available fund balance (including its $8.9 million reserve for economic uncertainties and a set aside for audit findings) totaled 3.7% of spending, just above the board's 3% policy. Fitch's assesses the district's gap closing capacity as limited relative to the expected revenue loss (about 4.2%) during a 1% GDP decline scenario. Fitch believes the presence of the state trustee would enable the district to make the difficult spending cuts needed to maintain at least the state required minimum 2% reserves throughout the economic cycle.

The district accumulated a large deficit in fiscal 2003 and requested an emergency loan from the state. Senate Bill 39 approved a $100 million loan which the district continues to repay annually. In connection with the emergency loan, the state appointed an administrator which temporarily replaced the board of education in managing the district. In fiscal 2009, the district board regained control and a state trustee was put in place until the loan is repaid (June 2026). The trustee has 'stay and rescind' powers over fiscal decisions, but more commonly the board and the trustee come to an agreement in advance of decisions.

The state controller was put in charge of the district's annual audits, in connection with the emergency loan. This resulted in significant delays in releasing annual audits. The district is authorized to use an independent auditor and recently released its fiscal 2015 audit and expects to issue its fiscal 2016 audit on time. The audits have qualified opinions because the district is unable to provide sufficient information to audit the associated student body (ASB) accounts at various schools and GAAP requires their inclusion for an unqualified opinion to be issued. Given the minor nature of the ASB accounts, Fitch has relied upon these audits for its IDR. In addition to the qualified opinions, the audits also note several material weaknesses in the district's internal controls over compliance that have notably resulted in audit findings related to state and federal grants. The district has been forced to set aside reserves related to the audit findings and to repay funds that it could not document spending in accordance with grant requirements. As of the end of fiscal 2015, the district had $5.1 million set aside (committed) for audit findings. District management reports that there will be no set aside for audit findings in the fiscal 2016 audit and as a result those funds will become part of its available reserves.

The state's school fiscal oversight regime (commonly referred to as AB 1200) results in generally conservative budgeting and multiyear forecasting and, as noted, the state trustee provides additional oversight by reviewing interim and other financial reports. Fitch expects that the state trustee would use her stay and rescind power to prevent the district from spending its reserves below the minimum level required by the state, adding an extra level of protection on top of management's own commitment to maintaining reserves above the state minimum. While the district's weak revenue performance has limited its ability to build reserves to more robust levels, the strong oversight framework supports an overall operating performance assessment that is slightly higher than the level suggested by scenario analysis.