News Column

Fitch Rates Austin ISD, TX's 2014A ULT Rfdg Bonds 'AAA' PSF/'AA+' Underlying; Outlook Stable

July 25, 2014

AUSTIN, Texas--(BUSINESS WIRE)-- Fitch Ratings assigns an 'AAA' rating to the following Austin Independent School District, Texas' (Austin ISD or the district) unlimited tax bonds (ULTs):

--$63.6 million ULT refunding bonds, series 2014A.

The aforementioned rating is based on a guaranty provided by the Texas Permanent School Fund (PSF), whose bond guaranty program is rated 'AAA' by Fitch.

Fitch also assigns an underlying 'AA+' rating to the series 2014A bonds and to the $79.9 million in ULT refunding bonds, series 2014B. Fitch also affirms the 'AA+' rating on the district's approximately $869.2 million (pre-refunding) in outstanding ULT bonds.

The Rating Outlook is Stable.

The bonds are scheduled for a negotiated sale on July 31, 2014. Proceeds from the sale will be used to refund outstanding commercial paper issued for capital projects, refund certain outstanding obligations for savings, and to pay issuance costs.

SECURITY

The bonds are payable and secured by an unlimited ad valorem tax pledge levied against all taxable property within the district.

KEY RATING DRIVERS

SOLID RESERVES: Management's conservative fiscal practices are projected to again narrow the year's moderately-sized structural imbalance budgeted and preserve a sound financial cushion that remains in line with established policy.

TAV GROWTH STRENGTHENS: The tax base is diverse and robust. Taxable assessed valuation (TAV) continues to strengthen after modest recessionary decline. Further TAV growth is projected over the near term.

STABLE REGIONAL ECONOMY: Economic indicators for the city of Austin (the city) indicate a generally sound service area with unemployment levels that remain below state and national levels despite solid labor force growth. Income and wealth metrics are slightly below those of the state and nation. Educational attainment levels equal or exceed those of the U.S.

MODERATE LONG-TERM LIABILITIES: Overall debt levels and other long-term liabilities of the district are moderate. Amortization of principal is slightly above average. Carrying costs are low and expected to remain manageable over at least the near term.

RATING SENSITIVITIES

DETERIORATION OF RESERVES: Sound reserve levels that provide significant financial flexibility underpin the high 'AA+' rating, particularly in light of the district's limited revenue-raising ability under the current school funding formula. Material deterioration of the district's financial position from a growing and unmitigated structural imbalance could signal a fundamental shift in its credit profile, leading to negative rating action. The Stable Outlook reflects Fitch's expectation that such shifts are unlikely.

CREDIT PROFILE

Austin ISD is the fifth largest school district in the state with nearly 130 campuses and a current enrollment of about 85,500, serving the city (general obligation bonds rated 'AAA' by Fitch) and about 852,000 residents.

FAVORABLE ECONOMIC CONDITIONS

While not immune to recessionary forces, the city's economy historically has been buffered by the large and stabilizing presence of state government as well as seven colleges and universities. The latter includes the University of Texas (the University of Texas System is rated 'AAA' by Fitch with a Stable Outlook), one of the largest public universities in the country. High-technology manufacturing is also a major employer, attracted to the area by a well-educated workforce and the availability of major research facilities. Year-over-year unemployment trends reflect further economic improvement as unemployment has continued to fall despite solid labor force growth. City unemployment declined to a low 3.8% in May 2014, which was down from 4.8% in May 2013 and below the state and U.S. rates of 5.1% and 6.1% respectively. Income and wealth levels as measured by median household income are slightly below those of the larger Austin-Round Rock-San Marcos metropolitan statistical area, the state, and the U.S.

TAV GROWTH STRENGTHENS

The district's tax base has historically been characterized by strong, annual TAV growth pre-recession given area population trends and the resulting economic expansion. It remained resilient over the recession, registering only one year of a modest TAV decline in fiscal 2011 and has since reflected steady increases. TAV grew by approximately 7% in fiscal 2014, which was up from 4% in fiscal 2013. Management assumes further, moderate TAV gain in fiscal 2015, which Fitch believes is reasonable given various new development projects underway, bolstered by a robust economy. Concentration among the top 10 taxpayers is minimal at 4%; about three of the top taxpayers are large, high-tech firms.

BUILD-UP OF RESERVE CUSHION IN PRIOR FISCAL YEARS

The district is considered property wealthy and relies almost entirely on local property taxes, but its funding is subject to the state's formula and a portion of the district's operating tax levy is effectively recaptured by the state for distribution to less wealthy school districts. For fiscals 2013 and 2014, these payments approximated $120 million and $128 million, respectively, or around 15% of total general fund spending.

The district generated large surpluses over fiscals 2010-2012 due to the receipt of one-time federal stimulus funds as well as significant budgetary cuts that addressed state funding reductions in the last biennium (fiscals 2012-2013). This combination allowed the district to maintain and improve upon its financial position. The district declared financial exigency in 2011, as required by state law, which allowed it to implement a significant reduction in force. Nearly 1,300 positions were eliminated by attrition or layoffs. Financial exigency ended roughly a year later on Jan. 30, 2012.

Reserve levels peaked at fiscal 2012 year-end with an unrestricted general fund balance of $244 million or nearly 31% of spending. The district has since then planned for a moderate use of reserves annually as the primary means to offset growth in spending and structural operating imbalance despite some improvement in state funding over the fiscal 2014-2015 biennium.

RELIANCE ON RESERVES MANAGEABLE TO DATE

Fiscal 2013 year-end results slightly improved upon management's previous expectations. The year's budgeted $28 million draw on reserves was narrowed to less than half at $12 million (or 1.5% of spending), enabled by management's conservative budgeting and spending practices. Unrestricted general fund reserves equaled $231 million or about 28% of spending, which remained comfortably above the district's stated 20% unassigned reserve policy. Liquidity as measured by general fund cash/investments totaled $277 million or a sound four months of general operational spending.

Management again anticipates using reserves for operations, although less than budgeted at fiscal 2014 year-end. This is despite an unanticipated loss of about $10 million in student-related state aid from the year's 1% enrollment loss that reversed prior years' steady and comparably sized enrollment gains. Tighter year-to-date spending assisted by some reduction in enrollment-related operating costs are projected to reduce the budgeted $32 million drawdown (about 4% of spending) to $18 million at fiscal 2014 year-end. Unrestricted fund balance is projected at about $213 million or just under 25% of spending.

The preliminary $904 million fiscal 2015 general operating budget assumes enrollment to remain flat to slightly declining, which is forecast over the near to intermediate term by the district's outside demographer. Structural operating imbalance is addressed with a similarly-sized $33 million drawdown on reserves (or 3.6% of budgeted spending) for the third fiscal year. Fitch expects this use of reserves will narrow again over the fiscal year given the district's historical operating performance. The district presently projects maintaining unassigned reserves in line with policy at just under 20% of spending by fiscal 2014 year-end.

A multi-year financial forecast through fiscal 2018 currently projects moderate although growing structural imbalance annually, up from $33 million in fiscal 2015 to $64.7 million (6.5% of general fund spending) in fiscal 2018, driven in large part by rising annual recapture payments from a growing tax base without counterbalancing spending actions and annually diminished reserve levels well below what Fitch would expect at the currently high rating category.

Fitch views these forecasts with some concern given the finite nature of the reserves, although recognizes the moderate size of the annual imbalance to budget and the likely conservative nature of the forecasts. Fitch assumes in the current rating action management will take appropriate steps to address the structural operating imbalance as the district nears its policy reserve threshold. Absent such developments, Fitch would likely reconsider the district's rating. An operating tax ratification election also remains available to the district that would generate about $30 million annually and require voter approval, although management indicates the timing and political will of the board to pursue this option remains uncertain.

TEXAS SCHOOL DISTRICT LITIGATION

In February 2013 a district judge ruled that the state's school finance system is unconstitutional. The ruling, which was in response to a consolidation of six lawsuits representing 75% of Texas school children, found the system 'inefficient, inequitable, and unsuitable and arbitrarily funds districts at different levels...'. The judge also cited inadequate funding and districts' inability to exercise 'meaningful discretion' in setting tax rates as constitutional flaws in the current system.

The judge agreed to reopen testimony in January 2014 after the Texas legislature restored $4.5 billion in school funding in its 2013 session. The increased funding levels apply to school district budgets in fiscal years 2014 and 2015. The judge will determine if the additional funding affected arguments made during the trial. It is anticipated that the original ruling, if upheld, will ultimately be appealed to the state supreme court.

DEBT AND OTHER LONG-TERM LIABILITIES MANAGEABLE

Overall debt levels are moderate at approximately $2,500 per capita and 2.7% of market value and little changed with this issuance. The district will refund all of its currently outstanding commercial paper with the majority of the series 2014A issuance; the district is one of few Texas school districts to utilize such a program. Principal amortization remains slightly above average at 54% in 10 years.

Solid TAV gains have generally mitigated the debt service tax rate impact of the district's previous borrowings, enabling the district to implement its capital plan with limited tax rate impact. The district expects to reduce its debt service tax rate by $0.02 per $100 TAV beginning in fiscal 2015 despite its planned near-term issuances, utilizing about $14 million of debt service fund balance and what Fitch believes to be are reasonable TAV growth assumptions. The district anticipates continued utilization of its commercial paper program (issuing about $125 million annually) and fixing it out into long-term debt allowable from its remaining bond authority, which totals about $550 million, largely for renewal/expansion of existing facilities.

Management indicates the district maintains enrollment capacity in its facilities district wide. Fitch anticipates district officials will likely implement some interim measures such as attendance rezoning to manage some of its additional near- to intermediate-term capital needs for the pockets of enrollment growth not included in the outstanding GO bond authorization.

Retiree pension and healthcare benefits are provided through the Teacher Retirement System of Texas (TRS), a cost-sharing multiple employer plan. The district's annual contribution to TRS is determined by state law as is the contribution for the state-run post-employment benefit healthcare plan; the district consistently funds its annual required contributions. District employees contribute to TRS for pensions at 6.4% of annual payroll, and the state pays the local district's contributions (6.4% of payroll in fiscal 2013), with the exception of district contributions for probationary employees and for benefits on employees' salaries that exceed the TRS statutory minimum. Other post-employment benefit (OPEB) contributions paid by the district are nominal as the state and employees also pay the bulk of these costs. Total pension and OPEB contributions made by the district in fiscal 2013 totaled less than 1% of governmental fund expenditures.

TRS is adequately funded at 81.9% as of Aug. 31, 2012, though Fitch estimates the funded position to be lower at 73.8% when a more conservative 7% return assumption is used. The state's payment of district pension costs is an important credit strength as it keeps overall carrying costs manageable in the face of a high and growing debt burden. Carrying costs for the district (debt service, pension, OPEB costs, net of state support) totaled a below-average 9% of governmental fund spending in fiscal 2013, made up largely of the district's annual debt load. Starting in fiscal 2015, pension contributions for all districts in the state will rise to 1.5% on the statutory minimum portion of payroll, from zero, increasing carrying costs further, although pass-through state aid is projected to largely offset the year's increase. Further increases in district funding requirements beyond fiscal 2015 could create additional budget pressure, which Fitch will monitor.

Additional information is available at 'www.fitchratings.com'.

In addition to the sources of information identified in the Tax-Supported Rating Criteria, this action was additionally informed by information from Creditscope, Texas Municipal Advisory Council, and IHS Global Insight.

Applicable Criteria and Related Research:

--'Tax-Supported Rating Criteria', Aug. 14, 2012.

--'U.S. Local Government Tax-Supported Rating Criteria', Aug. 14, 2012.

Applicable Criteria and Related Research:

Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

U.S. Local Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=841757

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Fitch Ratings

Primary Analyst

Rebecca C. Moses

Director

Fitch Ratings, Inc.

+1-512-215-3739

111 Congress Ave., Suite 2010

Austin, TX 78701

or

Secondary Analyst

Shane Sellstrom

Analyst

+1-512-215-3727

or

Committee Chairperson

Amy Laskey

Managing Director

+1-212-908-0568

or

Media Relations

Elizabeth Fogerty, New York, +1-212-908-0526

elizabeth.fogerty@fitchratings.com


Source: Fitch Ratings


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