AUSTIN, Texas--(BUSINESS WIRE)--Fitch Ratings has affirmed the rating on Tucson Unified School District No. 1, Arizona's (the district) outstanding debt as follows:
--approximately $183.6 million unlimited tax general obligation (ULTGO) bonds at 'AA-'.
The Rating Outlook is Stable.
SECURITY
The GO bonds are payable from an unlimited ad valorem tax levied against all taxable property within the district.
KEY RATING DRIVERS
STABILITY IN RESERVES: Expenditure cuts in operations and facilities have resulted in maintenance of a stable fiscal position. Internal liquidity has been adequate to avoid external borrowing, despite the ongoing delay of year-end state aid payments and revenue pressure stemming from enrollment decline.
SLOWER PACED RECOVERY: Improvement in home prices, employment trends, and assessed valuation has been relatively sluggish since the recession, particularly as compared to the Phoenix MSA. Nonetheless, the diverse regional economy remains stable with a good mix of higher education, military, and government employment, largely offsetting credit concerns regarding below-average income levels.
MODERATE LONG-TERM LIABILITIES: The overall debt burden is moderate, as are carrying costs. The district faces growing maintenance costs and declining state support for capital, but expects to meet its most pressing needs with pay-go spending.
RATING SENSITIVITIES
MATERIAL CHANGE IN FINANCES, ENROLLMENT: Weakening of reserves below the modest amounts Arizona school districts are typically permitted to maintain would not be consistent with the rating category. Conversely, continued positive operating results, a stabilized management and political environment, and a sustained trend of measurable enrollment gains would be viewed positively.
BUILDING CAPITAL PRESSURES: An elevated amount of unmet capital needs could require higher levels of pay-go, further pressuring operational spending, which could result in a downgrade.
CREDIT PROFILE
LARGE URBAN DISTRICT
Tucson is the second most populous city in Arizona. The district encompasses almost 230 square miles and provides public education to a sizable portion of the Tucson metropolitan statistical area (MSA). The Tucson MSA has roughly 1 million residents and has experienced strong population increases over the past decade. Educational attainment is comparable to national levels while income/wealth levels fall about 20% below state and U.S. averages.
ENROLLMENT LOSS PERSISTS
The district's relatively large enrollment base has realized a steady pattern of annual decline since 2007, due in part to charter and private school competition. However, fiscal 2016 enrollment trends to date remain stable year-over-year. Average daily membership totaled slightly less than 46,000 in fiscal 2015.
Fitch believes it is likely enrollment declines may persist over the near-term, and will carefully monitor this trend, as maintenance of structural balance will likely require adequate and timely cost-cutting measures, potentially including the unpopular decision of additional school closures.
SATISFACTORY FINANCES THOUGH CASH FLOW PRESSURE REMAINS
The district's financial profile has been pressured in recent fiscal years by state wide cuts to state aid and delays to education funding beginning in fiscal 2009. Nonetheless, district finances have remained generally stable despite these state funding cuts and delays, as well as those reductions in funding associated with ongoing enrollment declines.
Management's decision to temporarily offset the loss of federal stimulus funds and the reduction in other state revenue in fiscal 2013 with the use of reserves resulted in a moderately-sized $13.8 million (4.2% of spending) general fund net operating deficit. Still, the district preserved an unrestricted general fund balance of $31.1 million or a healthy 9.5% of spending, in line with prior expectations.
Sizeable spending cuts characterized fiscal 2014 operations, including the closure of some low-enrollment schools. The district implemented other expenditure cuts in line with a declining student base and also reduced the district's health insurance contribution. In total, general fund spending fell by 8% or about $26 million from the prior year. The district's unrestricted reserve cushion held fairly steady at $30.5 million or 10% of spending at fiscal 2014 year-end.
CONTINUED LAG IN FINAL STATE PAYMENT
The state has continued its practice of delaying its final payment to all school districts. This amount totaled about $44 million in fiscal 2014 for the district. However, delayed year-end payments are received in full within the district's fiscal-year encumbrance period; current state legislation requires the final state aid payments to be distributed to districts by July 15. The delay in state funds has not necessitated additional short-term borrowing, as other internal fund balances provided adequate liquidity support.
Management's projected year-end fiscal 2015 results include a modest net operating surplus as a result of spending levels below budget. Preliminary estimates of various fund balances that currently comprise the general fund on an audited basis (but are separately budgeted) total a stable $32 million or about 11% of the year's estimated spending.
The adopted fiscal 2016 general operating budget totals $302 million, up about 1% from the prior year. Administrative personnel cuts and stricter adherence to staffing standards offset other budget priorities, such as pay increases, some pay-go capital spending, and a reduced tax rate. Management anticipates some expenditure flexibility to improve upon budget as the year progresses, which Fitch believes is reasonable given the district's historical performance.
FUNDING FORMULA LIMITS DISTRICTS' FINANCIAL FLEXIBILITY
District funding is subject to the state's school funding equalization formula, which provides some revenue stability on a per pupil basis, but fairly modest local revenue-raising discretion and financial flexibility. Arizona school districts are limited by statute to maintain operating reserves at no more than roughly 4% of general spending. Larger reserve amounts must be used to reduce the next year's tax levy.
Property taxes presently provide a slightly larger portion of the district's total operating revenues (about 49% in fiscal 2014) while state funding contributes a reduced 43%. On a per pupil basis, the year's state funding level remained below fiscal 2007, reflective of ongoing pressure on the state's budget. The slightly higher amount of local property tax revenue is due to the additional revenue generated by the district through its tax levy allowed for desegregation purposes, which it expects to be able to continue to collect even after unitary status is achieved.
RECENT HOME PRICE AND EMPLOYMENT IMPROVEMENT
Growth of the city of Tucson's residential base has slowed from its peak in 2001, when it recorded 3,800 single-family home permits. An average of 350 new housing permits have been issued annually the past several years, but that number is up from 240 in fiscal 2011. Home prices also are showing improvement, with the March 2015 median sale price of $172,000 up nearly 6% from the prior year and 30% higher than the 2011 low.
Services, military, higher education and government are the area's prominent employment sectors. City unemployment declined to 5.9% in June 2015 from 6.5% the prior year, which was comparable to the state (5.9%), but slightly above the nation's rate (5.3%). The year's employment totals are now approaching the pre-recessionary 2008 peak.
MODEST AV GROWTH IN FISCAL 2016
The district's tax base is mostly residential; a stable list of top taxpayers comprised 5% of the total in fiscal 2014. Assessed valuations (AV) reflect a two-year reporting lag, and recessionary pressures on the district's tax base resulted in a five year period of AV decline (fiscals 2011-2015) that cumulatively totaled 25%.
This AV trend was reversed with a very modest 1% gain in fiscal 2016, reflective of a more muted and somewhat delayed return to growth, although Fitch notes the district was subject to less AV volatility on the downside as well when compared to other Phoenix local governments.
Proposition 117 (effective in fiscal 2016) limits the net assessed limited property value growth to 5% annually on existing properties; the 5% cap does not apply to new construction. However, the interest and sinking (I&S) tax rate can be increased to accommodate the change in valuation base and Fitch does not anticipate the new statute will constrain the district's ability to pay debt service.
MODERATE OVERALL DEBT BURDEN AND OTHER LONG-TERM LIABILITIES
Overall debt levels remain moderate at 4.4% of fiscal 2016 market value or approximately $2,780 on a per capita basis despite a recent increase in debt from overlapping issuers. Amortization of tax-supported principal is rapid at 74% in ten years.
The state has historically provided annual capital funding to all Arizona school districts, which could be supplemented with a locally-approved GO bond election or capital override to the tax levy. However, recessionary pressure on the state's budget beginning in fiscal 2010 led to a steady decline in this funding, which has continued through the current fiscal year. The district has lost approximately $100 million in capital funding from the state over fiscals 2010 - 2016.
Although enrollment trends do not pressure its school facilities, deferred facility renewal/replacement needs have subsequently built-up; the district must also periodically fund 'soft capital' needs such as technology, textbooks, and equipment. District leadership has yet to take action on any local funding solutions.
A soon-to-be completed facilities study will inform management's preliminary plans to approach voters for GO bond authorization (yet to be sized) in November 2016 for a variety of capital needs; the district exhausted its last GO authorization in 2010 and does not have a capital override in place. The district is also presently exploring what additional state funding might be available to address various facility deficiencies in fiscal 2016.
The district's pension plan, as well as death, disability and health insurance benefits, is administered through the Arizona State Retirement System (ASRS). The district has made 100% of its annually required contribution (ARC) for fiscal years 2012-2014 as directed by the state, equivalent to approximately $26 million in fiscal 2014.
The actuarially funded position for ASRS as of June 30, 2014 was 75.4%, although the funded position of the state administered program is estimated by Fitch to fall to 68% when a more conservative 7% investment return is assumed. Carrying costs for debt service, pension and other post-employment benefits (OPEB) through ASRS were moderate at 17.6% of fiscal 2014 governmental spending despite rapid amortization of tax-supported debt.
In addition to the sources of information identified in the report 'Tax-Supported Rating Criteria', this action was additionally informed by information from Creditscope and IHS Global Insight.
Additional information is available at 'www.fitchratings.com'.
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
Dodd-Frank Rating Information Disclosure Form
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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=990545
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https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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