Fitch Ratings downgraded the Aromas-San Juan Unified School District’s general obligation bonds to BB-plus from BBB-minus.

“The downgrade reflects the district’s extremely weak financial position, including negative general fund total and unreserved fund balances, deficit spending, projected operating deficits unless further action is taken, a difficult state funding environment, and the need for external borrowing to support cash flows,” Fitch analysts Amy Doppelt and Scott Monroe wrote in a report.

The downgrade affects just $11 million of debt, but it is one of the lowest school district ratings in California and reflects concern about the GO payments if the district’s operating results continue to weaken and force it into bankruptcy, Monroe said. The district had about $1.9 million of unrated certificates of participation outstanding at the end of fiscal 2007.

Monroe said he doesn’t expect Aromas-San Juan USD to file for municipal bankruptcy, but officials project negative cash balances of as high as $2 million in four out of 12 months in the current fiscal year and an annual deficit of $108,000, raising the possibility that the district will follow Vallejo, Calif., into bankruptcy.

The bankruptcy code is unclear about the treatment of general obligation bonds. Special pledged revenues are generally considered sacrosanct in municipal bankruptcies. In Vallejo, for instance, water revenue bonds continue to be paid and are unaffected by the city’s bankruptcy.

There remains “uncertainty about what would happen [to GOs] in a bankruptcy court,” Monroe said. He said the district’s fiscal problems stem from an unanticipated rise in special education costs, declining enrollment, a slowdown in development, and rising salaries.

Since recognizing the crisis, the district has cut $1.2 million of ongoing expenditures by reducing employee wages and capping benefits, eliminating 30 jobs, and increasing fees for services, Fitch said.

The San Benito County Board of Education has appointed a financial overseer with power to block new spending and contracts, and the county is considering a $3 million loan to the district to keep it solvent.

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