Fitch Affirms Dysart USD No. 89, AZ School Improv Bonds at ''AA-'; Outlook Revised to Negative

AUSTIN, Texas--(BUSINESS WIRE)--Fitch Ratings has taken the following rating action on Dysart USD No. 89 of Maricopa County, Arizona's (the district) bonds as part of its continuous surveillance efforts:

--$184 million in outstanding school improvement bonds affirmed at 'AA-'.

The Rating Outlook is revised to Negative from Stable.

KEY RATING DRIVERS:
--The Negative Outlook reflects the district's weakened financial and liquidity position stemming primarily from state funding delays and cuts in recent fiscal years. Ongoing state aid delays have necessitated additional short-term borrowing to meet the district's liquidity needs.

--In addition, the Negative Outlook addresses the district's limited ability to raise funds for capital projects that may be needed to accommodate enrollment growth.

--The area economy continues to demonstrate weakness, evidenced by elevated unemployment levels and above-average levels of foreclosures and home value declines. Income and wealth levels are generally above average.

--Historically rapid expansion of the district's tax base reversed course beginning in fiscal 2010. Deeper AV declines were realized in fiscal years 2011 and 2012; another moderate decline is projected for fiscal 2013.

--Given the weakened housing market, very rapid enrollment growth trends in what was the fastest-growing district in the state have slowed.

--Overall debt levels are moderate; the pace of amortization is slow, which is atypical for an Arizona school district, but reflective of the district's significant growth pressures experienced in prior years.

--Fitch takes comfort that given expectations of a slow economic recovery the district maintains some flexibility in its tax levy to moderate the overall tax impact to taxpayers from a rising annual debt service schedule.

WHAT COULD TRIGGER A RATING CHANGE:
--Lack of improvement in the district's liquidity position.

--Operating deficits that lead to a decline in general fund reserves.

--Insufficient available resources to meet growth-related capital needs.

--Declines in housing and other economic indicators greater than current expectations.

SECURITY:
The bonds are secured by the district's unlimited ad valorem tax pledge levied against all taxable property within the district.

CREDIT PROFILE:
Located northwest of Phoenix in central Maricopa County, the district encompasses 140 square miles and serves an estimated population of 164,000 in the city of Surprise and the towns of El Mirage and Youngtown. Overall economic conditions have weakened since the Phoenix metropolitan statistical area (MSA) has been affected more substantially than other parts of the nation by housing market declines. Although down from a prior high of 11.3% in fiscal 2010, unemployment levels in the city of Surprise remain elevated at 10% in April 2011 and above the unemployment rates of 8.0%, 8.9% and 8.7% for the county, state and nation, respectively. Nonetheless, Luke Air Force Base, one of the largest fighter pilot training bases in the world located within the district, remains a stabilizing presence in the local economy. Area income and wealth levels are generally above average

The district's tax base is relatively diverse and experienced rapid growth from fiscal years 2000 through 2009, largely driven by rising home values as well as ongoing residential and attendant retail/commercial expansion. Despite these gains, only slightly more than half of the district is built-out. Tax base gains reversed course, however, beginning in fiscal 2010, due largely to residential value declines that are reflected in assessments on a lagging basis. Comparable to other Arizona local governments, the district's secondary assessed valuation (SAV) has fallen to pre-2008 levels with another significant decline of 18% in fiscal 2012, which was the third consecutive year of AV decline. Management conservatively projects a more moderate SAV decline of up to 11% for fiscal 2013.

Rapid residential development, particularly in the city of Surprise, led to rapid enrollment gains, with the district becoming one of the fastest-growing school districts in Arizona. Double-digit gains slowed recently to a reduced but still solid 4% beginning in fiscal 2009 due to the area's weakened housing market and absence of new residential development. Now at nearly 24,000 students, district officials project similar enrollment gains over the near-term, given present economic conditions.
District financial operations have been stressed over the last few years due to several factors including the state's fiscal imbalance and hold-back of school aid, which comprises over half of the district's operating revenues. Additional pressure on district financial operations includes rising property tax delinquencies, since the state equalization school funding formula does not offset current-year declines in property tax collections from locally-approved overrides. To address the declining revenue environment and to provide more stable financial footing, management implemented multi-year expenditure savings, which included permanent staffing changes and salary freezes.

The district has struggled to meet cash flow needs even with increased short-term borrowing through the County Treasurer's Office as ending general fund cash balances for the last two fiscal years were negative, net of auditor adjustments. Also, the district has adjusted its property tax levy annually in order to recapture previously uncollected property tax revenue from prior years.

Despite cost-cutting efforts, the district's typically above-average reserve levels were greatly reduced in fiscal 2009. The district implemented state mandated budget cuts, but declines in state funding led to a reduction in the unreserved general fund balance to $440,000 or less than 1% of spending, down significantly from $11.6 million or 9.5% of spending in the prior fiscal year. Outstanding receivables on the balance sheet expected from the state grew sharply in fiscal 2009 and again in fiscal 2010 while cash and investments dwindled. Given fiscal 2010's ongoing but somewhat reduced state funding pressures, the unreserved general fund balance strengthened modestly but remained low at roughly $3.8 million or 2.8% of spending.

While school district budgetary control is primarily through expenditures, districts can seek voter approval for extra local funding through capital and operating property tax overrides. Historically, the district has maintained all available overrides, although most recently, management decided not to pursue renewal of the district's capital override, given declining capital needs. Recent renewal of the district's two operating overrides, combined at 15% and worth roughly $17.5 million (contributing not quite 13% of total operating revenue) as fully implemented in fiscal 2011, provides the district with continued financial flexibility over the near term. Further spending reductions were made in the fiscal 2011 M&O budget and management currently estimates year-end reserves or carry forward on a cash basis in all levy funds (including the general fund) at $8 million or about 6% of M&O spending assuming the state becomes current on all lagged payments due for the year. The proposed $141.4 million fiscal 2012 M&O expenditure budget was generally held flat as compared to fiscal 2011 and it is expected to be adopted shortly.

Overall debt levels are moderate at 1.6% of full market value or roughly $1,350 on a per capita basis. Largely comprised of the district's outstanding debt, these debt levels have historically been assisted by rapid tax base growth and significant state support for new schools in prior fast-growth years. Since 2000, the district has added 15 elementary schools and three high schools to serve its growing student population.

Although roughly $68 million remains unissued from a 2006 bond authorization, district officials have no material, near-term debt plans due in part to lower enrollment growth pressures. Of concern to Fitch, however, is the district's lack of capacity within its Class B bond statutory limit (no more than 10% of net SAV in indebtedness) to meet intermediate-term capital needs. While the state has historically provided facility funding for growing school districts, the availability of such funding remains somewhat uncertain, given the state's ongoing fiscal crisis. The district estimates that it would be unable to issue additional debt for the next eight to nine years under stable SAV assumptions.

Principal amortization is slow at 37% in 10 years, reflective of the rapid growth pressures experienced since fiscal 2000. The district's current debt service schedule rises to reach MADS at $19.7 million in 2024, up from $11.2 million in fiscal 2012. The district's pension plan, as well as disability, death and healthcare benefits, is through the Arizona State Retirement System (ASRS); the system's funded position remains satisfactory at 79.3% as of June 30, 2009 or 71.4% using Fitch's 7% discount rate assumption. The district has made 100% of its annual required contribution (ARC) for fiscal years 2008 - 2010, which totaled $8.8 million in fiscal 2010.

Additional information is available at www.fitchratings.com.

In addition to the sources of information identified in the report 'Tax-Supported Rating Criteria', this action was additionally informed by information from Creditscope, University Financial Associates, LoanPerformance, Inc, and IHS Global Insight.

Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria' (Aug. 16, 2010);
--'U.S. Local Government Tax Supported Rating Criteria' (Oct. 8, 2010).

Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=548605
U.S. State Government Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=564546

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