Fitch Affirms Progreso ISD, TX at 'BB+'; Outlook Revised to Stable

AUSTIN, Texas--()--Fitch Ratings has affirmed the 'BB+' rating on Progreso Independent School District, TX's (the district) $27.6 million unlimited tax (ULT) bonds outstanding.

The Rating Outlook is revised to Stable from Negative.

SECURITY

The bonds are payable from an annual unlimited property tax levy.

KEY RATING DRIVERS

REVISED OUTLOOK: The Stable Outlook reflects the district's progress in stabilizing its financial position, primarily through staff rightsizing. The district still faces the potential claw-back of past state aid for ineligible non-resident students, but sufficient reserves are expected to readily absorb this contingency. The tightened verification process of student residency is expected to reduce unanticipated revenue pressures in the future.

PROGRESS EXPECTED ON AUDIT FINDINGS: The district's fiscal 2014 audit is unqualified but carries over a large number of audit findings from the previous year as expected. The district reports substantial progress in resolving these findings and none are expected in the fiscal 2015 audit.

STATE CONSERVATORS REMAIN: Conservators remain assigned by Texas Education Agency (TEA) to the district with oversight authority and broad power to make and influence management decisions, including a veto of board decisions. A new superintendent, business manager and federal programs director were recently hired.

MIXED DEBT PROFILE: Debt-to-market value is very high due to the low tax base wealth, and amortization is moderately below average. However, fixed costs for debt service and retiree benefits are quite affordable due to annual state support. Existing capital needs will be funded on a pay-go basis and debt plans are limited.

WEAK TAX BASE: Tax base wealth is very low and top taxpayers are moderately concentrated. Recent taxable assessed valuation (TAV) growth has been positive but volatile. 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. Such metrics are not unusual for smaller school districts located along the U.S.-Mexico border.

RATING SENSITIVITIES

SUSTAINED FINANCIAL IMPROVEMENT: Failure to maintain structural balance and improved financial management practices may lead to further negative rating action. Conversely, a trend of stable operations and audited financial improvements may lead to positive rating action.

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 around 1,900.

OUTLOOK REVISION

The Stable Outlook reflects the district's return to structural balance through the elimination of 58 positions in fiscal 2015, which is projected to result in an operating surplus of $2.5 million (15% of spending). It also reflects management's progress in improving its financial management practices with the assistance of a state education service center (ESC). The ESC provided business office support, financial oversight, human resources support, and student attendance support. Additionally, Fitch views the hiring of a new leadership team as an important step in returning stability to the district.

STRUCTURAL IMBALANCE AND MANAGEMENT WEAKNESSES

Fitch's downgrade of the district to 'BB+' with a Negative Outlook in 2014 stemmed from the confluence of both financial and governance related problems. A significant structural imbalance in fiscal 2013, due to overstaffing and transfers for construction cost overruns, was accompanied by a qualified opinion on the fiscal 2013 audit plus a high 22 audit findings.

These findings reflected many of the problems discovered by TEA's investigation regarding significant gaps in governance, internal controls and financial management practices. The lack of accountability and non-compliance issues spanning various tiers of leadership ultimately resulted in the arrests of the board president and an assistant superintendent on bribery charges, as well as the departure of the district's business manager. In response, TEA appointed two conservators in 2014, and they continue to work with the district. Management expects all of the audit findings will be resolved in the fiscal 2015 audit.

STATE AID OVERPAYMENTS

The district's financial challenges were further exacerbated by a TEA investigation that revealed 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 $1.6 million for the biennium and resulted in a reduction of the district's fund balance by a similar amount in the fiscal 2014 audit. Despite the adverse adjustment, the fiscal 2014 unrestricted fund balance totaled a still adequate $3.7 million or 18.3% of spending.

TEA also contends that similar overpayments for 100 non-Texas residents were received by the district in fiscal 2014, which TEA had planned to deduct from the fiscal 2015 funding amount. The district has appealed TEA's finding and contends a smaller number of non-Texas residents was counted in the district's ADA during that period. TEA has not ruled on the district's appeal, and the district has set aside $735,000 for this contingency. The district has enhanced its processes for verifying students' residency, which presumably will limit this exposure going forward.

PROJECTED FISCAL 2015 SURPLUS, FISCAL 2016 BUDGET ADOPTED

The fiscal 2015 budget reflected the loss of all 100 students disputed by TEA as non-eligible. To offset the loss of about $750,000 in state revenue, management reduced personnel; the interim administration had identified substantial overstaffing in maintenance personnel and other non-teaching positions.

The elimination of 58 positions is projected to result in a $2.5 million (15% of spending) net surplus, increasing the unrestricted fund balance to about $6.2 million or 36.4% of spending. Management plans to set aside $700,000 and $735,000 of the surplus for roof repairs and the potential claw-back of fiscal 2014 state aid, respectively. Netting out these set asides, the estimated financial cushion represents a still solid 28% of spending.

The proposed fiscal 2016 budget includes pay hikes and assumes a modest 1% increase in ADA. Funded on a flat O&M tax rate of $1.04 per $100 TAV, the proposed budget is projected to result in a $1 million general fund surplus.

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 March 2015 unemployment rate of 7.5% is down from 9.3% a year-prior but remains well above the state and national averages of 4.2% and 5.6%, respectively. Likewise, local wealth indicators traditionally have lagged significantly behind state and national averages, with market value per capita a low $28,000 and per capita income equal to only 39% of the national average.

District TAV has grown by a compound annual average of 4.2% since fiscal 2011. Recessionary TAV losses were limited to a 6.4% reappraisal decline in fiscal 2011. Moderate taxpayer concentration exists, with the top 10 taxpayers accounting for 13.5% of fiscal 2014 TAV, led by a construction company with 3.3% of the total.

The 2015 district estimated population of 8,200 is small. Student ADA in the district remained flat in recent years before declining by 2% and 6% in fiscal years 2014 and 2015, respectively. The fiscal 2015 ADA decline reflects the elimination of all non-Texas residents identified by TEA. The district is budgeting a modest 1% gain in ADA in fiscal 2016 to reflect a new pre-K program for 3 year olds, which Fitch considers reasonable.

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 the state, and therefore the district is heavily dependent on state aid for operating and debt service support. State financial support has consistently comprised around 80% of general fund revenues; 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 14.3%, reflecting the very low property wealth levels. Debt per capita is more moderate at $3,843. The district's substantial state debt service support, which when applied as a cost offset, reduces annual debt service costs to less than 2% of governmental expenditures.

The pace of principal repayment remains modestly below average at 46% in 10 years. Debt service is level over the medium term and descends thereafter through final 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 $342,000 or a nominal 1.1% of fiscal 2014 governmental expenditures. Combined fixed costs for debt service and pension and OPEB ARCs consumed only 3.2% of fiscal 2014 governmental spending.

TEXAS SCHOOL FINANCE LITIGATION

A Texas district judge ruled in August 2014 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 and was the second such ruling in the past two years, 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.

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 would likely follow with changes intended 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, University Financial Associates, S&P/Case-Shiller Home Price Index, IHS Global Insight, and National Association of Realtors.

Applicable Criteria

Tax-Supported Rating Criteria (pub. 14 Aug 2012)

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

U.S. Local Government Tax-Supported Rating Criteria (pub. 14 Aug 2012)

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

Additional Disclosures

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Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=988962

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
Jose Acosta
Senior Director
+1-512-215-3726
Fitch Ratings, Inc.
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Shane Sellstrom
Analyst
+1-512-215-3727
or
Committee Chairperson
Steve Murray
Senior Director
+1-512-215-3729
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Jose Acosta
Senior Director
+1-512-215-3726
Fitch Ratings, Inc.
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Shane Sellstrom
Analyst
+1-512-215-3727
or
Committee Chairperson
Steve Murray
Senior Director
+1-512-215-3729
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com