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Rating Action:

Moody's Downgrades Duluth ISD 709, MN's GO to Ba1; Outlook Negative

Global Credit Research - 25 Oct 2017

New York, October 25, 2017 -- Issue: Taxable General Obligation Capital Facilities Bonds, Series 2017B; Rating: Ba1; Rating Type: Underlying LT; Sale Amount: $615,000; Expected Sale Date: 10/30/2017; Rating Description: General Obligation;

Issue: Taxable General Obligation Capital Facilities Bonds, Series 2017B; Rating: Aa2; Rating Type: Enhanced LT; Sale Amount: $615,000; Expected Sale Date: 10/30/2017; Rating Description: General Obligation;

Issue: Taxable General Obligation Facilities Maintenance Bonds, Series 2017A; Rating: Ba1; Rating Type: Underlying LT; Sale Amount: $3,640,000; Expected Sale Date: 10/30/2017; Rating Description: General Obligation;

Issue: Taxable General Obligation Facilities Maintenance Bonds, Series 2017A; Rating: Aa2; Rating Type: Enhanced LT; Sale Amount: $3,640,000; Expected Sale Date: 10/30/2017; Rating Description: General Obligation;

Summary Rating Rationale

Moody's Investors Service downgrades Duluth Independent School District No. 709, MN's underlying general obligation unlimited tax (GOULT) and full term certificates of participation (COP) ratings to Ba1 from Baa2. Moody's also downgrades the district's annual appropriation COPs rating to Ba2 from Baa3. Concurrently, Moody's assigns Ba1 underlying GOULT ratings and Aa2 enhanced ratings to the district's $3.6 million Taxable General Obligation Facilities Maintenance Bonds, Series 2017A and $615,000 Taxable General Obligation Capital Facilities Bonds, Series 2017B. Following the sale, the district will have $51 million in general obligation (GO) bonds, $147 million in full term COPs, and $33 million in annual appropriation COPs. The outlook on the underlying ratings is negative.

The downgrade of the underlying GO rating to Ba1 from Baa2 reflects the district's declining enrollment, as charter school competition has weakened the district's per pupil operating revenue. Negative budget variances and the use of reserves for capital projects have also depleted operating liquidity. Based on fiscal 2018 projections, district management will need to either cash flow borrow or delay the timing of certain expenditures to ensure the cash position is sufficient to meet other operating expenses, although it has not yet secured an arrangement with a liquidity provider. The Ba1 rating also reflects fluctuations in cash levels throughout the year and an elevated debt burden. These challenges are balanced against a strong tax base that serves as a regional economic center.

The full term COPs are rated on parity with the underlying GO rating due to the lack of annual appropriation risk.

The annual appropriation COPs are rated one notch below the underlying GO rating due to the risk of non-appropriation and the more essential nature of the financed project (school buildings).

The Aa2 enhanced ratings on the Series 2017A and Series 2017B GO bonds reflects the additional security provided by the State of Minnesota's School District Enhancement Program (MSDE). The programmatic rating is notched once from the State of Minnesota's Aa1 GO rating and carries a stable outlook, reflecting the stable outlook on the state's GO debt.

Rating Outlook

The negative outlook on the underlying ratings reflects the district's extremely narrow reserves and lack of near-term plans to improve its financial position. Based on fiscal 2018 projections, the district will need to either issue cash flow notes or delay the timing of certain expenditures to ensure the cash position is sufficient to meet other operating expenses, including certain debt service payments. An agreement with a liquidity provider has not yet been arranged. The outlook also reflects a long-term trend of declining enrollment, which is expected to continue to pressure the district's operating position.

The stable outlook on the enhanced rating is based on the stable outlook assigned to the State of Minnesota's GO rating.

Factors that Could Lead to an Upgrade

- Material and sustained improvement to operating reserves and liquidity

- Upward movement in State of Minnesota's GO rating (enhanced)

Factors that Could Lead to a Downgrade

- Inability to either secure cash flow borrowing or maintain a cash position sufficient to meet expenditures in fiscal 2018

- Failure to rebuild operating reserves and liquidity

- Continued enrollment declines that further pressure operating revenue

- Increases in debt levels or fixed costs

- Downward movement in the State of Minnesota's GO rating (enhanced)

- Weakening of the MSDE program mechanics (enhanced)

Legal Security

The district's GOULT debt, including the Series 2017A and 2017B bonds, are secured by the district's pledge and authorization to levy a dedicated property tax unlimited as to rate and amount. The security benefits from a statutory lien but not a lockbox structure.

The district's full term COPs do not carry the district's full faith and credit pledge but are secured by a separate, dedicated statutorily authorized lease levy. The obligation of the district to make rental payments is absolute and unconditional and it is not subject to annual appropriation.

The district's annual appropriation COPs are secured by lease payments which are subject to annual appropriation. The pledged assets are school buildings, which we deem to be a more essential asset.

Use of Proceeds

Proceeds of the Series 2017A and Series 2017B bonds will finance capital improvements to various facilities throughout the district.

Obligor Profile

Duluth ISD 709 provides pre-kindergarten through twelfth grade education to residents of the City of Duluth as well as all or portions of five surrounding townships. The district serves a resident population of approximately 93,000 and reports a fiscal 2018 enrollment of 8,738.

Methodology

The principal methodology used in the general obligation underlying rating was US Local Government General Obligation Debt published in December 2016. The principal methodology used in the lease-backed rating was Lease, Appropriation, Moral Obligation and Comparable Debt of US State and Local Governments published in July 2016. The principal methodology used in the enhanced rating was State Aid Intercept Programs and Financings: Pre and Post Default published in July 2013. Please see the Rating Methodologies page on www.moodys.com for a copy of these methodologies.

Regulatory Disclosures

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Benjamin VanMetre
Lead Analyst
Regional PFG Chicago
Moody's Investors Service, Inc.
100 N Riverside Plaza
Suite 2220
Chicago 60606
US
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Rachel Cortez
Additional Contact
Regional PFG Chicago
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Releasing Office:
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JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

No Related Data.
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