OREANDA-NEWS. Fitch Ratings has assigned an 'AAA' rating to the following general obligation (GO) (dedicated unlimited ad valorem property tax) bonds to be issued by the San Diego Unified School District (SDUSD, or the district):

--$131.5 million 2016 (GO) refunding bonds series R-5;
--$145.7 million 2016 GO refunding bonds series SR-1;
--$2.7 million 2016 GO bonds (election of 2008, series J-1) (federally taxable);
--$39 million 2016 GO bonds (election of 2008, series J-2).

The SR-1 bonds are expected to price the week of April 4, the R-5 bonds the week of April 18, and the J1 and J2 bonds the week of May 2. Proceeds of series R-5 and SR-1 will be used to refund outstanding bonds for savings. Proceeds of series J-1 and J-2 will be used to construct and improve neighborhood schools.

The Rating Outlook is Stable.

SECURITY
Bonds are secured by an unlimited ad valorem property tax levied on all taxable property in the district.

KEY RATING DRIVERS
PLEDGED SPECIAL REVENUE: The 'AAA' bond rating 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.

AFFLUENT, DIVERSE ECONOMY: SDUSD benefits from its location in San Diego, with an affluent and diverse economy and tax base, modestly increasing population, and declining unemployment rate.

MODERATE DEBT; MANAGEABLE CIP: Overall debt is moderate but will rise as the district implements its large capital investment plan (CIP) and as existing debt amortizes somewhat slowly. Fitch's concerns about debt levels are mitigated somewhat by tax constraints prior to issuance which will require assessed valuation (AV) growth in order to continue to issue new debt.

IDR REFLECTS CHALLENGED FINANCES: The 'A+' Issuer Default Rating includes consideration of the district's somewhat challenged financial operations. The distinction between the 'AAA' rating on the bonds and the 'A+' issuer rating reflects Fitch's assessment that bondholders are legally insulated from any operating risk of the district.

RATING SENSITIVITIES
STABLE TAX BASE: The ULTGO rating and IDR are sensitive to material negative changes in the district's tax base and economy, which Fitch believes are unlikely.

IDR SENSITIVE TO FINANCIAL PERFORMANCE: The 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
SDUSD serves an area of 211 square miles encompassing most of the population of the city of San Diego (ULTGO bonds rated 'AA-', Positive Outlook) and about 85% of its AV. The district is the second largest in the state, educating over 100,000 students in grades K-12.

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. payment interruption) in the event the district were to file for bankruptcy.

Fitch has reviewed and analyzed legal opinions provided by district counsel stating that certain provisions of the state constitution (primarily article XIIIA) which limit and direct the use of pledged property tax revenues for bond repayment would 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 focuses on the district's economy, tax base and debt burden, without regard for the district IDR, because Fitch believes that bondholders are insulated from any operating risk of the district.

AFFLUENT, DIVERSE TAX BASE & ECONOMY
The district's economy and tax base are large, diverse and exhibit above-average socio-economic indicators. District AV rose 6.1% in fiscal 2016 to $157.9 billion. This follows a 6.2% increase in fiscal 2015 and 4% in fiscal 2014. AV performed quite well throughout the recession, declining a modest 1.9% in fiscal 2011 before beginning its slow recovery.

The top-10 secured taxpayers make up just 4.8% of total fiscal 2016 secured AV. Top taxpayers include industrial, hotel, office, apartment and retail concerns as well as one of the region's several theme parks.

The job growth outpaced labor force growth contributing to an unemployment rate of 4.5% in December 2015 compared to 5.2% the year prior. Educational attainment is above average, particularly for bachelor's and advanced degrees, as the city benefits from the presence of large higher education institutions including UC San Diego, San Diego State University, and the University of San Diego.

Nonetheless, the poverty rate is above the state and national averages and the district has identified about 63% of its student body as English-language learners, in foster care, or receiving free or reduced lunch.

MODERATE OVERALL DEBT; SIZEABLE CIP
Overall debt totals about $5.5 billion, with district debt accounting for over 50%. The district retains about $1.6 billion in bonding authority under proposition Z (approved in 2012) and another $1.4 billion under proposition S (2008). The district plans to issue these bonds as 25-year and (proposition Z) 30-year (proposition S) fixed-rate bonds with moderately rising debt service and maintain a maximum tax rate of $126.70 per $100,000 of AV.

Debt levels are expected to rise given the somewhat slow amortization of currently outstanding bonds (37% in 10 years) and the planned amortization rate of future bond issuances. AV growth may moderate some of the increase in the debt-to-market value.

The district's large CIP is fully funded with the bond authorizations and includes renovation of 38 schools which are in the design phase with another 16 in construction. To date the district has completed 97 major projects. The upgrades include new classroom buildings, renovations and modernizations, and classroom technology and infrastructure.

IDR REFLECTS SATISFACTORY FINANCIAL POSITION, BUT FORECAST DEFICITS POSE CHALLENGE
In addition to the tax base and debt levels of the district, the'A+' IDR incorporates the district's somewhat challenged financial operations.

The district's current financial position is satisfactory; however, increased spending on compensation and lower class sizes has outpaced the recent improvement in state funding. Sustained declining enrollment contributes to fiscal challenges, as enrollment drives a large portion of revenues. The rating also incorporates the district's demonstrated ability to contain costs as needed.

The district ended fiscal 2015 with a $36 million net surplus after transfers (3%) resulting in an unrestricted fund balance of $143.2 million, or a solid 12% of spending. This surplus and the 4.5% surplus from fiscal 2014 were largely the result of transfers into the general fund from sales of surplus real estate. Such use of real estate sales proceeds was temporarily enabled through state legislation and expired at the end of 2015. Without these transfers, the district would have had four consecutive years of deficits.

The district's second interim report (approved March 8, 2016) includes a forecast deficit in the current year ($22 million), down from the originally budgeted $53 million use of total general fund balance. The multiyear projection identifies a roughly $100 million structural imbalance for fiscal 2017, growing to $145 million in fiscal 2018. If state funding does not eventually increase sufficiently to eliminate the deficit, the district plans to make about $25 million in budget adjustments in fiscal 2017 and about $109 million in fiscal 2018. Given its history of maintaining adequate fund balances, Fitch believes this may be challenging but achievable.

During the recession, the district negotiated salary deferrals and furloughs, suggesting some willingness of the labor force to work with the district to balance budgets.

RISING CARRYING COSTS
Carrying costs for debt service, pension and OPEB are low at about 12% of governmental spending, but rising. Debt service costs will rise markedly as the district implements its CIP, and retiree costs will rise as the pension systems grapple with low funded levels. The state-sponsored teachers retiree system (CalSTRS) has particularly weak funding levels due to years of statutory contribution rates below actuarially required levels. Based on the state's current plan the district contribution rate will increase to 19% in fiscal 2021 from 12.6% in fiscal 2016.