Fitch Rates Denton ISD, TX Ser 2014C ULT Rfdg Bonds 'AAA' TX PSF/'AA' Underlying; Outlook Stable

AUSTIN, Texas--()--Fitch Ratings assigns an 'AAA' rating to the following Denton Independent School District, Texas' (the district) unlimited tax (ULT) bonds:

--$14.3 million ULT refunding bonds, series 2014-C.

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 'AA' underlying rating to the series 2014C bonds and affirms the 'AA' underlying rating on the district's approximately $736 million (non-accreted) outstanding parity bonds.

The bonds are scheduled to sell Nov. 12 via negotiated sale. Proceeds will be used to refund a portion of the district's outstanding bonds for savings and to pay issuance costs.

The Rating Outlook is Stable.

SECURITY

The bonds are payable from an unlimited property tax levied against all taxable property within the district. The bonds are also insured as to principal and interest repayment from a guaranty provided by the PSF.

KEY RATING DRIVERS

ROBUST FINANCIAL CUSHION: The district maintains ample reserves and liquidity despite some recent use of fund balance for non-recurring outlays. Strong financial performance has been aided by conservative budgeting practices and annual enrollment growth.

PART OF STRONG REGIONAL ECONOMY: The district's solid and diverse tax base benefits from its proximity to the Dallas-Fort Worth (DFW) metropolitan area, which continues to outpace the nation in total employment, population, and income growth. District residents enjoy access to employment opportunities in the DFW metro area as well as local employment opportunities anchored in the education, healthcare, and manufacturing sectors.

EXPANDING TAX BASE: Taxable assessed valuation (TAV) growth continues to strengthen after a modest, one-year contraction during the recession. Fitch believes further expansion over the near-term is reasonable given the ongoing pace of commercial and residential development underway and ample land available in the district.

MINIMAL DEBT FLEXIBILITY: The district is highly leveraged as a result of the rapid enrollment growth that occurred over the past decade. Key debt ratios are high, amortization is slow, and a high debt service tax rate - which is at the statutory $0.50 per $100 TAV test for new debt issuance - limits capital flexibility. The district is largely reliant on realizing solid TAV growth in excess of enrollment to provide additional debt capacity under the statutory test.

RATING SENSITIVITIES

SHIFT IN FUNDAMENTALS: The rating is sensitive to shifts in fundamental credit characteristics including the district's strong financial position. The district's history of maintaining solid reserves while addressing operating and capital needs indicates continued rating stability.

FUTURE ENROLLMENT GROWTH PRESSURES: Fitch believes the district presently maintains a modest level of capacity its school facilities. The district may experience capital pressures if enrollment growth substantially outpaces tax base growth.

CREDIT PROFILE

DIVERSE & GROWING LOCAL ECONOMY ENHANCED BY DFW METRO PROXIMITY

Denton ISD is located approximately 35 miles north of Dallas and Fort Worth in Denton County, at the convergence of Interstate Highways 35 East and 35 West, and encompasses nearly 169,000 residents. Proximity to the DFW metro area and the access provided by major highway, air, and rail transportation have attracted a variety of industry and business to the area as well as an expanding service sector and manufacturing development that continues to diversify the district's mostly residential tax base.

Education and health services top the list of major area employers, which provided a measure of stability during the recession. The University of North Texas and Texas Woman's University are located in the city of Denton. Area employment indicators are strong, evidenced by continuing employment and labor force gains in the city and county. The Denton County unemployment rate improved to 4.5% from 5.4% for the 12-month period ending September 2014 despite a solid 2% gain in labor force and has continued to trend below area, state, and national rates.

TAX BASE GAINS STRENGTHEN

TAV grew at an average annual growth rate of roughly 4.5% from 2008-2015, reflective of continued expansion since the recession and a strong 12%- increase in fiscal 2015. Fitch believes prospects for continuing TAV gains are positive and further double-digit rates seen prior to 2009 may be realized over the near-term due to development occurring within the district, the expanding housing market, and growing regional economy. Build-out of the district is presently estimated at roughly 30%.

Population and enrollment gains, which were significant over the past decade, are also continuing. Enrollment totals approximately 27,000 students in fiscal 2015, which reflects a more moderate 2.6% year-over-year gain after a period of enrollment growth at 4%-5% or about 1,000 students annually over fiscals 2011-2013. Nonetheless, a steady uptick in students is projected by the district's demographer with annual enrollment growth of 2.5%-3% anticipated over the next five years.

SOLID FINANCIAL PERFORMANCE, RESERVES, & LIQUIDITY

Financial performance has remained strong despite the continuing capital and operating pressures associated with rapid enrollment growth. Unreserved/unrestricted general fund reserves have been no less than 27% over the last five fiscal years (fiscals 2009-2013). Historically conservative budgeting and spending practices have typically enabled actual operating performance in excess of expectations. The district posted positive results in three of the last five fiscal years, adding $23 million (roughly 12% of fiscal 2013 spending) to total general fund balance from fiscal 2009 to fiscal 2013. These results were notable given changes in funding formula and sizeable state budget cuts that occurred over the last biennium (fiscals 2012-2013). In addition, management favorably funds most of its non-facility capital needs (buses, technology, etc) with pay-as-you-go capital spending from operating reserves maintained well above the district's formal reserve policy floor (no less than two months or roughly 17% of spending) . About $17 million was set aside to be spent down over fiscal 2013 and 2014 for this purpose.

Fiscal 2013 year-end results improved upon budgeted expectations. Reduced expenditures, inclusive of slower than projected pay-go, resulted in a $2.6 million operating surplus. A $6.4 million transfer out primarily for future capital spending purposes resulted in the year's $3.8 million drawdown on reserves. Nonetheless, unrestricted reserves remained solid at $73.1 million or nearly 37% of spending by fiscal 2013 year-end. Liquidity in fiscal 2013 totaled a strong $94 million or over five months of general operational spending as well.

Prior projections for fiscal 2014 included some catch-up in pay-go capital spending with the expected use of fund balance widening from the $4 million budgeted to roughly $8 million. Salary increases and increased staffing due to the opening of a new middle school drove most of the original drawdown in the year's $208.6 million adopted budget. Nonetheless, unaudited fiscal 2014 results anticipate improving upon mid-year budget assumptions with roughly break-even operations and a modest $3 million addition to fund balance, bolstered by proceeds from a one-time insurance settlement and the district's typical operating conservatism.

The $212.5 million fiscal 2015 operating budget includes a modest $4.7 million drawdown on reserves (2% of spending) in part for pay-go funding of some of the district's capital needs (technology, buses) and start-up costs for the opening of a new elementary school. Management reports expenditures are running comparable to budget and there has been modest growth in enrollment-related revenues due to somewhat higher than budgeted actual enrollment. Fitch does not foresee substantial changes to the district's strong financial performance and position.

HIGH DEBT RATIOS STEM FROM ENROLLMENT-DRIVEN CAPITAL NEEDS

The district's debt profile is Fitch's key credit concern. Overall debt ratios are high while the pace of principal amortization is slow at 34% in 10 years, reflecting the district's fast-growth environment and the related need to meet facility demands while attempting to limit the effect on existing taxpayers.

Overall debt levels comprise a very high 11.3% of market value and $8,755 per capita and are slightly higher when accreted interest from capital appreciation bonds (CABs) is included. The high overall debt load is a function of the direct debt and large amount of debt from the city of Denton and various fresh water supply districts. Debt service also consumes a high 18% of the fiscal 2013 operating and debt service spending. Nonetheless, Fitch views the district's historically strong voter support for its bond programs as mitigating some concern over these debt levels.

The district's debt portfolio contains about 30% of mostly hedged variable-rate debt, which is slightly over what Fitch views as an acceptable range for the 'AA' rating category. Although the high debt service burden somewhat elevates this concern, the district maintains a policy to keep variable-rate debt issuance at a maximum of 30%. Moreover, approximately 34% of the outstanding variable-rate debt is currently synthetically fixed and all other outstanding variable-rate debt presently carries a fixed interest rate in its initial, three-year rate period.

DEBT SERVICE TAX RATE LIMITS CAPITAL FLEXIBILITY

Of additional concern to Fitch is the district's limited flexibility in meeting future capital needs due to a debt service tax rate ($0.50 per $100 TAV in fiscal 2015) that is at the statutory limit for new debt issuance. The tax rate cap for new money debt somewhat mitigates the risk of sharp increases in debt levels over the near term, but it can also serve to constrain fast-growth districts' ability to meet capital needs, absent sufficient tax base growth. The district presently maintains a modest level of student capacity in its existing school facilities, although student growth pressures persist. Management has proactively prioritized its bond program on classroom space and is otherwise cash funding or postponing additional capital needs. Subsequently, the district does not expect to issue the remaining $31 million from the 2007 bond authorization for support facilities over the near to intermediate term.

The current issuance is projected to provide some modest, level debt service savings over fiscals 2019-2023 and maintains the district's existing 30-year amortization schedule. The $0.01 increase to the debt service tax rate implemented in fiscal 2015 against the year's very strong TAV gain is planned to allow the district to early retire a modest portion (about $8 million) of its outstanding principal. Sale of the outstanding $156 million new money bond authorization, which was approved by a strong 68% of voters in November 2013, is contingent upon tax base growth and the additional debt capacity provided against the statutory $0.50 test. Management indicates issuance may be feasible within the next two or three fiscal years given projections of further strong TAV growth over the near-term.

OTHER LONG-TERM LIABILITIES MANAGEABLE

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 manageable 15.8% of governmental fund spending in fiscal 2013 due largely to slow principal amortization and they are expected to remain manageable despite a moderately ascending debt service schedule through fiscal 2017. Starting next fiscal year (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. Increases in district funding requirements beyond fiscal 2015 could create additional budget pressure.

TEXAS SCHOOL FUNDING LITIGATION

For the second time in the past 18 months a Texas district judge ruled in August 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 underfunded. The judge also ruled that local school property taxes are effectively a statewide property tax due to lack of local discretion and therefore are unconstitutional.

Following a similar ruling in February 2013, the judge granted a motion to reopen the lawsuit four months later after state legislative action that partially restored state funding levels and made other program changes. The Texas attorney general has appealed the judge's latest ruling to the state supreme court. If the state school finance system is ultimately found unconstitutional, the legislature will be directed to make changes to the system to restore its constitutionality. Fitch would view positively any changes that include additional funding for schools and more local discretion over tax rates.

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, IHS Global Insight, National Association of Realtors, and the Texas Municipal Advisory Council.

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=919515

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Contacts

Fitch Ratings
Primary Analyst
Rebecca C. Moses
Director
+1-512-215-3739
Fitch Ratings, Inc.
111 Congress Ave., Suite 2010
Austin, TX 78701
or
Secondary Analyst
Steve Murray
Senior Director
+1-512-215-3729
or
Committee Chairperson
Arlene Bohner
Senior Director
+1-212-908-0554
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526 (New York)
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Rebecca C. Moses
Director
+1-512-215-3739
Fitch Ratings, Inc.
111 Congress Ave., Suite 2010
Austin, TX 78701
or
Secondary Analyst
Steve Murray
Senior Director
+1-512-215-3729
or
Committee Chairperson
Arlene Bohner
Senior Director
+1-212-908-0554
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526 (New York)
elizabeth.fogerty@fitchratings.com