News Column

Fitch Rates Northwest ISD, TX's ULT School Building Bonds 'AAA'PSF/'AA' Underlying; Outlook Stable

August 26, 2014

AUSTIN, Texas--(BUSINESS WIRE)-- Fitch Ratings assigns an 'AAA' rating to Northwest Independent School District, Texas' (the district) unlimited tax (ULT) bonds as follows:

--$75 million ULT school building bonds, series 2014.

The 'AAA' rating on the bonds 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 rating of 'AA' to the series 2014 bonds.

The bonds are scheduled for negotiated sale on August 27. Proceeds will be used for various capital projects.

Fitch also affirms the following ratings:

--Approximately $665 million in outstanding ULT bonds at 'AA'.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by ad valorem taxes levied against all taxable property within the district, without limitation as to rate or amount. The bonds are also secured by the Texas Permanent School Fund (PSF), whose bond guaranty program is rated 'AAA' by Fitch.

KEY RATING DRIVERS

STRONG FINANCIAL PROFILE MAINTAINED: General fund reserves and liquidity remain solid, maximizing the district's financial flexibility. Management's sound and proactive fiscal practices have historically enabled annual operating surpluses despite a trend of ongoing, rapid enrollment growth.

WEAK DEBT PROFILE: Capital needs from the rapidly growing enrollment will continue to drive already high debt levels. Amortization is slow. Carrying costs are expected to remain manageable despite an ascending debt service schedule. The fixed cost burden is tempered in part by the district's overall financial flexibility and some remaining tax rate cushion below the statutory $0.50 tax rate ceiling for new debt.

TAX BASE CONCENTRATION: Taxpayer concentration remains above average and remains highly concentrated in mineral reserves due to the district's location over portions of the Barnett Shale formation.

TAV RESTORED: Static natural gas values combined with ongoing residential and commercial development growth resulted in an increase in taxable assessed valuation (TAV) for fiscal 2015 after four years of modest declines. The district's growth prospects are positive given its proximity to the Dallas Fort-Worth (DFW) metro area, availability of affordable land, and its location within the Barnett Shale, one of the largest natural gas fields in the U.S.

RATING SENSITIVITIES

FINANCIAL, TAX BASE DETERIORATION: Material deterioration of solid reserve levels that provide a high level of financial flexibility and/or prolonged, significant weakening of the tax base could signal a fundamental shift in the district's credit profile, leading to negative rating action. The Stable Outlook reflects Fitch's expectation that such shifts are unlikely over the near-term.

CREDIT SUMMARY

The district is located in the northwest part of the Dallas-Fort Worth (DFW) metropolitan area and encompasses a large 232 square miles that includes 16 rural communities in Denton, Tarrant, and Wise counties. Population and enrollment growth has been rapid since 2000 spurred by the availability of affordable land and location within the broad DFW metro. Enrollment growth moderated slightly due to a weaker housing market since the recession, but remains rapid. The district typically adds between 1,000-1,500 new students per year. Annual enrollment gains have remained in line with demographic studies that project steady increases in student enrollment of about 7% through fiscal 2018; district enrollment totals just over 20,000 students in fiscal 2015.

FINANCIAL PROFILE A CREDIT POSITIVE

Financial performance has been strong historically, characterized by operating surpluses, solid reserves, and ample liquidity. Sound management has helped to navigate the operating pressures associated with rapid enrollment growth, changes in funding formula, and recent cuts to state funding.

Audited fiscal 2013 results were better than budgeted with a $4.4 million net operating surplus after transfers (roughly 3% of the year's spending) compared with a $2.7 million budgeted net deficit. Unrestricted general fund balance at fiscal 2013 year-end rose to a solid $60.5 million or 42% of spending, well above the district's informal target of 33%. General fund liquidity also remained solid with nearly $85 million of cash and investments, or about 7 months of spending, at year end. The district has an additional $34 million in reserves (excluding bond proceeds) in the capital projects fund that is available for general fund operations if needed.

Unaudited fiscal 2014 results point to break-even operations. The district's fiscal 2015 budget was adopted with a planned modest $2.7 million draw on reserves. Historically conservative budgeting practices and the district's current robust reserves mitigate concerns over the modest budgeted deficit.

The district's current five year financial forecast projects annual operating gaps that grow to a substantial $22 million in fiscal 2018 due to the expiration of certain state revenues that are currently provided for tax relief under the legislation that changed the school funding formula effective in fiscal 2007. Approximately 30% of Texas school districts still received this type of tax relief funding in fiscal 2014. Fitch recognizes the forecasted imbalance is material, but also acknowledges that the district has built-up very high reserves in preparation for this funding uncertainty. Given management's history of conservative budgeting practices and robust reserves, Fitch believes the district will continue to preserve a strong financial posture in the long term. Moreover, pending school district litigation and the upcoming legislative session may result in additional funding changes that are not reflected in the forecast.

VOLATILE MINERAL VALUES DRIVE FLUCTUATING TAV

Fitch believes the district's tax base will remain subject to some additional variability going forward resulting from its above-average exposure to the energy sector and the potential for fluctuating mineral values through build-out. While TAV losses pose minimal operational risk in the scope of the current school funding formula, TAV declines could apply pressure to the district's already high debt profile and capital plans.

Sizeable growth was previously realized in the district's tax base due to its location over workable portions of the Barnett Shale field. Rising mineral values coupled with rapid residential development led to an average of 15% annual TAV gains from fiscal 2005-2010. However, modest annual average TAV declines of nearly 2% followed over fiscals 2011 - 2014 primarily due to a decline in mineral values.

For fiscal 2015, the district's TAV losses are expected to be restored at slightly over the $11 billion TAV posted for fiscal 2010. The district projects similar growth of 7.5% annually through fiscal 2019 and then moderating to 1% growth by fiscal 2025. Fitch believes the near term growth assumptions are somewhat optimistic, but believes it reasonable that continued residential and commercial development should add to TAV over the near-term.

Taxpayer concentration is down slightly but remains high at 21% in fiscal 2014, led by Devon Energy Corp at a sizeable 8% (Fitch Long-term Issuer Default Rating 'BBB' with a Stable Outlook).

HIGH DEBT LEVELS TO REMAIN ELEVATED

Overall debt levels are very high at $9,615 per capita and 7.3% of market value. Principal amortization is very slow with about 30% retired in 10 years. Inclusive of this issuance, annual debt service is projected to rise steadily from nearly $46.5 million in fiscal 2015 to reach maximum annual debt service (MADS) at $64 million in 2028. The district's debt profile is primarily comprised of fixed-rate debt with some use of capital appreciation bonds and a low amount (2% of outstanding principal) of variable rate bonds. While the high debt burden is a credit concern, Fitch notes that the fixed cost burden is mitigated in part by the district's overall financial flexibility as reflected in ample reserves and some remaining tax rate cushion below the statutory $0.50 tax rate ceiling for new debt.

This issuance is the second installment of a $255 million bond program authorized by voters in 2012 for new school facilities and other district improvements. After this issuance, the district will have $130 million bond authorization remaining from this program. Voters were promised a maximum tax rate increase of $0.07 per $100 TAV for the 2012 bond program which was implemented in fiscal 2014. The district plans to issue the remaining authorization over two more years depending mostly on TAV growth to maintain the tax rate at the current $0.41 per $100 TAV.

Management currently maintains modest flexibility in its debt and capital plans and expects to push back construction of a new middle school by about a year. Fitch will continue to assess the district's capital needs and debt plans and their effect on the already high key debt ratios, diminishing tax rate capacity for new debt, and overall budget flexibility. The 2012 authorization is expected to meet the district's capital needs over roughly the next four years, a large portion of which is for construction of the district's third high school that is expected to open in fiscal 2016. The district also has $45 million in unissued bond authorization from its 2008 election with no near-term issuance plans. Management reports that all bond projects related to this program were completed below budget.

OTHER LONG-TERM LIABILITIES MANAGEABLE

The district contributes to the Teacher Retirement System of Texas (TRS), a cost-sharing, multiple-employer defined benefit pension plan. The district's pension contribution, which is set by state law is 6.6% of payroll and is currently paid by the state on behalf of the district. However, districts are susceptible to future funding changes by the state as evidenced by a relatively modest 1.5% (approximately $1.5 million for the district) of salary contribution requirement effective fiscal year 2015. As of August 31, 2013, the TRS reports its pension trust fund actuarial valuation funding position is at 80.8%. Other post-employment (OPEB) benefits are also provided through TRS. The district's required contribution for OPEB in fiscal 2013 was a modest $520,000.

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.

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, and the 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:

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=857654

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Fitch Ratings

Primary Analyst

Gabriela Gutierrez, CPA, +1-512-215-3731

Director

Fitch Ratings, Inc.

111 Congress Avenue Suite 2010

Austin, TX 78701

or

Secondary Analyst

Shane Sellstrom, +1-512-215-3727

Analyst

or

Committee Chairperson

Arlene Bohner, +1-212-908-0554

Senior Director

or

Media Relations

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

elizabeth.fogerty@fitchratings.com

Source: Fitch Ratings


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