News Column

Fitch Downgrades Progreso ISD, TX to 'BB+'; Outlook Negative

August 11, 2014

AUSTIN, Texas--(BUSINESS WIRE)-- Fitch Ratings has downgraded the following Progreso Independent School District (the district) unlimited tax (ULT) bonds:

--$28.5 million ULT bonds, series 2006, 2010, 2010 refunding, 2011, 2011A, 2012 to 'BB+' from 'A-'.

Fitch removes the bonds from Rating Watch Negative and assigns a Negative Outlook.

SECURITY

The bonds are secured by an unlimited property tax levied annually against all taxable property within the district. Additional security is provided by the Texas Permanent School Fund (PSF) guaranty, whose bond guaranty program is rated 'AAA' by Fitch.

KEY RATING DRIVERS

DETERIORATING FINANCES: The downgrade reflects the adverse financial impact of the district's weak governance and management practices, including a structural imbalance caused by overstaffing, counting non-Texas residents as part of its average daily attendance (ADA), and reducing its debt service tax rate below the required level.

FINANCIAL MANAGEMENT LAPSES: The district's qualified opinion on its fiscal 2013 audit along with a large number of audit findings calls into question the reliability of reported information. Board inaction delayed the district's progress in resolving many of its management shortcomings.

BUDGET PRESSURES IN FISCAL 2015 AND BEYOND: The Negative Outlook reflects the district's difficult prospects for achieving structural balance in light of the state's planned withholding of state aid overpayments. Prolonged management lapses also reduce the reliability of financial data.

STATE CONSERVATORS ASSIGNED: The Texas Education Agency (TEA) has assigned two conservators to the district with oversight authority and broad power to make and influence management decisions, including a veto of board decisions going forward. While Fitch views this action positively, the impact of enhanced oversight is still unfolding and is not yet incorporated into the rating.

MIXED DEBT PROFILE: Debt-to-market value is very high due to the low tax base wealth, and amortization is below average. However, fixed costs for debt service and retiree benefits are quite affordable due to annual state support. Future capital needs are minimal.

WEAK TAX BASE: Tax base wealth is very low and top taxpayers are moderately concentrated in agriculture. TAV growth is occurring but at a much slower rate than historical growth due to lower levels of building activity. Tax collection rates are below average.

LIMITED BUT STABLE ECONOMY: The district's economy is fairly limited with high unemployment, high poverty, and low wealth. Fitch notes that such metrics are not unusual for smaller school districts located along the U.S.-Mexico border.

RATING SENSITIVITY

GOVERNANCE IMPROVEMENTS: Prolonged delays in appointing permanent leadership positions or lack of progress in resolving the district's numerous audit findings in the fiscal 2015 audit will lead to a rating downgrade.

FINANCIAL STABILIZATION: A lack of progress in restoring structural balance to the district's operating and debt service funds will lead to a rating downgrade.

DATA RELIABILITY: Inability to provide Fitch with consistently reliable financial data could result in withdrawal of the rating.

CREDIT PROFILE

The district is located on the U.S.-Mexico border in Hidalgo County and includes the town of Progreso, a small trading center. District attendance has fluctuated in recent years but remains at around 2,000.

SCHOOL BOARD INACTION

The district's tenuous position, cited by Fitch in a press release dated Feb. 21, 2014, was compounded by the school board's repeated inability to achieve a quorum and take action on certain key items such as the appointment of an interim superintendent. Since the election of three new board members in May 2014, the board is now meeting regularly, appointed an interim superintendent, and approved a one-year contract with a state education service center (ESC). The ESC will provide business office support, financial oversight, human resources support, and student attendance support. The appointment of the interim superintendent and the ESC contract was approved by the state conservators.

FISCAL 2013 OPERATING RESULTS AND AUDIT FINDINGS

The fiscal 2013 audit posted a large $3.1 million (15% of spending) net deficit due primarily to a $2.3 million transfer for the completion of the science and technology building. The balance of the deficit ($947,000 or 4.4% of spending) is due to a structural imbalance fueled by greater than budgeted staffing. The net deficit reduced the unrestricted fund balance to $5.2 million (24.4% of spending) from $8.4 million (42.7%) from a year prior. Liquidity remained ample at over 3.5 months of operating expenses despite the draw down.

The district received a qualified opinion on its fiscal 2013 audit plus a high 22 audit findings that echoed many of the problems discovered by TEA's investigation regarding significant gaps in internal controls and financial management practices. Although some progress has been made, management expects most of the findings will remain unresolved for the fiscal 2014 audit which is viewed negatively by Fitch.

STATE AID OVERPAYMENTS

A TEA audit revealed ADA discrepancies within the district's alternative school as well as errors in the lunch counts for the free and reduced-price lunch program. A separate TEA investigation discovered that the district had been including 100 non-Texas residents, equal to about 5% of its enrollment base in its ADA for fiscal years 2012 and 2013. These discrepancies led to the district receiving an aggregate state aid overpayment of $1.8 million for the biennium which TEA had planned to deduct from fiscal 2015 state revenues. The district has appealed TEA's finding and contends a smaller number of non-Texas residents was counted in the district's ADA during fiscal 2012 & 2013. TEA is awaiting the district's response and will not take action for the time being.

Although fiscal 2014 state revenues were not officially part of the TEA's investigation, TEA has indicated similar overpayments for 100 non-Texas residents were received by the district during this period. As a result, the fiscal 2014 budget was amended to reflect $659,000 (3% of general fund revenue) in unearned revenue. The timing of TEA's claw back for fiscal 2014 overpayments has not yet been determined.

FISCAL 2014 FINANCIAL PRESSURES

The new management team froze expenses and deferred certain expenditures in response to fiscal 2013's structural imbalance and the impending claw back of state revenues. Year to date cash is adequate at $5.5 million and management projects balanced operations are possible. However, Fitch notes that any overpayments will be posted as a liability (unearned revenue), leading to a significant fund balance decline.

FISCAL 2015 BUDGET PRESSURE

The proposed fiscal 2015 budget is still under development but management has indicated that it will reflect the loss of all 100 ADA disputed by TEA as non-eligible. To offset the loss of about $750,000 in state revenue, management will propose a reduction in staffing. The new administration has identified substantial overstaffing in maintenance personnel and other non-teaching positions. Fitch will monitor the board's willingness to right size district staffing and enable prudent financial management.

DEBT SERVICE SHORTFALL

Annual state support for debt service comprises a high 80% of unlimited tax bond debt service but is based on local taxing effort. A reduction of $0.05 per $100 TAV in the fiscal 2014 debt service tax rate led to a $300,000 (13% of spending) shortfall in local and state revenues for state support. To offset this shortfall, the district transferred a similar amount from the general fund (equal to 1.5% of spending), further exacerbating fiscal 2014 budget pressures. The new administration is investigating this discrepancy and plans to budget a debt service tax rate increase of $0.0425 (for a total of $0.33) to fully fund its debt service obligation in the proposed fiscal 2015 budget.

2010 BOND PROJECT ON HOLD

Construction of the science and technology building, funded with voter approved 2010 bonds, was halted eight months ago after the project's architect/contractor was arrested on federal bribery charges. The project is 70% complete but Fitch notes that costs are likely to increase under a new contractor.

Management's goal is to restart the project once its financial position is stabilized. TEA's substantial debt service support of the project's bonds may complicate the project's financing if such support is withdrawn due to its inactive status.

LIMITED BUT STABLE ECONOMY

Tourism, agriculture and trade with Mexico are the leading sectors of commerce in Hidalgo County. The Progreso-Nuevo Progreso International Bridge, expanded in 2003, has also enhanced the area's role in foreign trade activity. Unemployment rates in the county historically have been significantly higher than state and national levels. The May 2014 unemployment rate of 8.6% is down from 10.5% a year-prior but remains well above the state and national averages of 5.1% and 6.1%, respectively. Likewise, local wealth indicators traditionally have lagged significantly behind state and national averages, with market value per capita a low $25,000 and per capita income equal to only 37% of the national average.

District taxable assessed valuation (TAV) has rebounded modestly over the last three years and recouped a 6.4% reappraisal losses posted in fiscal 2011. This deceleration is significant compared with an average annual growth rate of about 14% from fiscal years 2006 to 2010. Moderate taxpayer concentration exists, with the top 10 taxpayers accounting for 12% of TAV.

The 2014 district population is small and estimated at just over 8,000. Student ADA in the district remained flat in recent years before declining by 2% in fiscal 2014. The district is budgeting a 5% reduction in ADA in fiscal 2015 to reflect the elimination of all non-Texas residents identified by TEA.

VERY LOW PROPERTY WEALTH BRINGS SUBSTANTIAL STATE SUPPORT

A major determinant in the amount of state financial aid for Texas school districts is local property wealth levels. The district's property wealth per student is among the lowest in state and, therefore, the district is heavily dependent on state aid for operating and debt service support. State financial support has consistently represented at or around 80% of general fund revenues and totaled 83% in fiscal 2013; local property taxes account for less than 10%. Tax collections, typical of the border region, are somewhat weak but have improved in recent years due to a change in delinquent tax collection procedures.

ELEVATED DEBT RATIOS WITH AFFORDABLE FIXED COSTS DUE TO STATE SUPPORT

The district's debt-to-market value ratio is very high at 16.4%, reflecting the very low property wealth levels. Debt per capita is more moderate at $3,859. The district's substantial state debt service support, which when applied as a cost offset, reduces annual debt service costs to a low 1.8% of governmental expenditures.

The pace of principal repayment remains below average at 40% in 10 years. Debt service is level over the medium term and descends thereafter through maturity. Current facility capacity is projected as adequate over the next five years.

District employees participate in the Teacher Retirement System of Texas (TRS), a cost sharing, multiple-employer pension system. Contributions are substantially made by plan members and the State of Texas on behalf of the district, significantly reducing the annual retiree costs for the district. The district's annual required contribution for pension and other post-employment benefits equaled $292,000 or a nominal 1.2% of fiscal 2013 governmental expenditures. Combined fixed costs for debt service and pension and OPEB ARCs consumed only 2.9% of fiscal 2013 governmental spending.

TEXAS SCHOOL FINANCE 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.

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

In addition to the sources of information identified in Fitch's Tax-Supported Rating Criteria, this action was additionally informed by information from CreditScope, University Financial Associates, S&P/Case-Shiller Home Price Index, IHS Global Insight, National Association of Realtors.

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:

U.S. Local Government Tax-Supported Rating Criteria

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

Tax-Supported Rating Criteria

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

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=848996

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE '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. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.



Fitch Ratings

Primary Analyst

Jose Acosta

Senior Director

Fitch Ratings, Inc.

111 Congress Avenue, Suite 2010

Austin, TX 787801

+1-512-215-3726

or

Secondary Analyst

Analyst

Leslie Cook

+1-212-908-5006

or

Committee Chairperson

Managing Director

Amy Laskey

+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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