The downgrade is based on financial deterioration; the weakening local economy, historically concentrated in automotive manufacturing; and continued student enrollment declines in the face of charter school competition. The Stable Outlook reflects Fitch's expectation of financial improvement in fiscal 2008 and 2009 as concerted spending cuts should help the district achieve operating balance. Additionally, the district has completed much of its capital plan, which addressed almost every school building, so moderate debt levels are expected to decline going forward although debt amortization is slow, with 32% of principal retired in ten years.

Dayton City School District serves about 155,000 residents primarily of the city of Dayton, in southwest Ohio. Now equal to about 16,000 students, enrollment has declined at an average 2% annually in the past five years, due to both population loss and significant charter school competition. The district has proactively addressed enrollment declines by reducing an estimated 1,200 positions since 2002, and has also reduced programs and services such as high school busing in its efforts to restore fiscal balance while still focusing on academic quality. Importantly, the district improved its Ohio school report card ranking to 'academic watch' from 'academic emergency' three years ago, while graduation rates continue to increase. Fitch believes that the district will struggle to maintain quality while continuing to cut the budget, as most discretionary programs have now been pared and budget reductions will likely involve the elimination of academic programs as well as class size adjustments.

In fiscal years 2006 and 2007, the district fully expended its general fund reserves as concerted budgetary cuts were not enough to counter rising educational costs. Revenue growth was, and continues to be, severely limited, as the district's most recent operating levy campaign failed in 2007. Academic improvements came at the cost of general fund reserves, as general fund unreserved balances declined to a negative 2.8% of spending for the year ended June 30, 2007, from 13.4% of spending just two years earlier.

Preliminary estimates of fiscal 2008 indicate the general fund achieved a modest general fund cash balance. The district anticipates returning to the electorate in November 2008 for an operating levy renewal, expected to generate approximately $9 million annually. If it does pass, management would prudently use the additional revenue to stabilize existing programs, earmarking about 25% of the levy for a cash reserve. The district's five year forecast achieves modest financial balances with no assumed growth in available revenues and expenditures growing slightly through the period. Both expenditure controls and operating levy renewal will be important fiscal elements to regaining overall financial stability.

Dayton is also experiencing an increasingly weakened local economy, as larger regional employers such as GM continue to retrench and consolidate facilities, causing smaller auto parts suppliers to disappear as well. Wright-Patterson Air Force base employs over 20,000 civilian and military personnel, providing some stability to the local economy, but a significant component of Dayton's large urban core remains under the poverty line and city per capita income of $15,755 equals just 62% of the US average. While home prices have declined only slightly, the area has experienced a significant increase in housing foreclosures. These significant economic and financial vulnerabilities will continue to pressure the district in the near and medium term.

Fitch issued an exposure draft on July 31, 2008 proposing a recalibration of tax-supported and water/sewer revenue bond ratings which, if adopted, may result in an upward revision of this rating (see Fitch research 'Exposure Draft: Reassessment of the Municipal Ratings Framework').

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.