Fitch Ratings has assigned a rating to Lodi Unified School District, California's (the district's) bonds as follows:
--$50 million 2011 general obligation refunding bonds rated 'AA-'.

The bonds will be sold via negotiated sale the week of Oct. 10, 2011.
Proceeds will be used to refund outstanding debt for net present value savings.

In addition, Fitch downgrades the following ratings:
--Outstanding district general obligation bonds to 'AA-' from 'AA';
--Outstanding Lodi Unified School District School Facilities Improvement
District #1, California (the SFID) general obligation bonds to 'AA-' from 'AA'.

The Rating Outlook is Stable.
--Weak Economy Prompts Downgrade: The downgrade reflects prolonged and significant local economic weakness, including a very high unemployment rate, further housing market price declines, year-over-year employment losses, and estimates of a fourth consecutive year of significant tax base contraction.
--External Factors Pressuring Finances: The downgrade additionally reflects the ongoing challenged state funding environment, the possibility of a significant mid-year funding reduction, declining enrollment, and concerns that significant cost-cutting to date will make further substantial cost cutting more challenging to achieve, in spite of impressive performance by management
to date.
--Very Strong Management Performance: The 'AA-' rating reflects very strong management practices, including the district's proactive approach to balancing operations by implementing deep expenditure reductions, maintenance of a sound financial cushion that nonetheless is vulnerable to further state funding and enrollment losses, and contingency planning in the event of further reductions.
--Mixed Debt Profile: The district's adequate debt profile benefits from low capital needs with no plans for further issuances in the near term; however, debt levels are moderate and principal amortization is slow.

The district's GOs are secured by an unlimited property tax pledge on all taxable property within the district. The SFID's GOs are secured by an unlimited property tax pledge on all taxable property within the SFID territory.

The district's economy remains under considerable pressure. The City of Lodi's July unemployment rate registered a high 13.4%, which is above state and national levels, but well below county levels. Employment levels fell 1.3% year over year, but unemployment did not rise due to a similar contraction in the labor force. This suggests the employment participation rate may be falling as discouraged workers leave the workforce. City home prices continue to fall, with secondary effects on assessed value (AV) levels. Fiscal 2012 AV is down an estimated 4.3% in fiscal 2012, marking an accelerated decline from the prior year's loss. Total peak to trough AV losses total a cumulative high 16.2% for the district, and an extremely high 29.6% for the SFID.

Given continued recent home price declines and weak employment data, Fitch believes that AV may continue to fall through at least fiscal 2013, which will reflect home values as of Jan. 1, 2012. The impact of AV declines on California school districts is mitigated somewhat by state-wide school funding procedures, wherein the state must back-fill lost property tax revenues up to the per pupil guaranteed funding level. However, increased reliance on state funding raises exposure to state funding deferrals. Further, a weak employment market likely will continue to pressure enrollment, which looks set to decline for a fourth
consecutive year.

Although the SFID's tax base is smaller, less mature, and more volatile than that of the district, Fitch does not believe this relative weakness is sufficient to warrant a lower rating than that of the district's GOs. The tax rate needed for SFID debt service is quite low relative to the total, and Fitch believes it could withstand a significant increase without materially affecting taxpayers' ability to pay. Further, due to participation in the county's Teeter plan the district receives 100% of levied taxes, regardless of actual
collection rates.

The district's financial position is sound but vulnerable to a number of risks. General fund operations produced a $7.5 million deficit in fiscal 2010(the last year for which an audit was available), lowering the total and unreserved general fund balances to satisfactory levels of $34.9 million (14.7% of expenditures and transfers out) and $26.4 million (11.1%), respectively.
$2.5 million of the deficit reflected the transfer out of funds to pre-fund the district's other post employment benefits (OPEB) liability.

Unaudited actual general fund operations for fiscal 2011 indicate an impressive $22.1 million surplus owing to aggressive cost cutting, the receipt of $4.8 million of federal education jobs funds, and conservative budgeting assumptions, including the prior assumption that the state would implement a $250 per ADA funding cut that never transpired. The adopted budget for fiscal
2012 shows a $3.5 million surplus, though a drawdown may occur if the state implements a mid-year funding reduction, as explained below.

In spite of this impressive financial performance, the district will need to grapple with a continued challenging funding environment. If state revenues fail to reach targeted revenue levels by December, automatic education funding cuts would be implemented on a sliding scale that could reduce the district's fiscal 2012 funding by up to $9 million. These funding cuts would arrive at a time when federal stimulus funds cease, and in a declining enrollment environment.

Further, already substantial cost-cutting to date will make future reductions more challenging. Nonetheless, management has identified at least $7.8 million of spending that could be eliminated, if necessary, and the district has acted aggressively and prudently throughout the recession to balance operations and to grow the district's financial reserves.

The district's debt profile is adequate. Overall debt levels are moderate overall at $2,820 per capita, or 3.5% of AV. Amortization is slow, with just 11% and 33% of principal retired over five and 10 years, respectively. Capital needs are modest, and the district has no plans for further debt.

Primary Analyst
Scott Monroe
Associate Director
Fitch, Inc.
650 California Street
San Francisco, CA 94122
Secondary Analyst
Andrew Ward
Associate Director
Committee Chairperson
Amy Laskey
Managing Director