Fitch Rates Canutillo ISD, TX ULTs 'AAA' PSF, 'AA-' Underlying; Outlook Stable

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

--$9.2 million ULT refunding bonds, series 2016.

The 'AAA' rating is based on a guarantee provided by the Texas Permanent School Fund (For more information on the Texas Permanent School Fund, see 'Fitch Affirms Texas Permanent School Fund at 'AAA'; Outlook Stable' dated Aug. 5, 2015.)

The bonds are expected to price via negotiated sale the week of Dec. 14. Proceeds will be used to refund outstanding debt for interest cost savings.

Fitch also assigns an underlying rating of 'AA-' to the series 2016 bonds and affirms the 'AA-' underlying rating on the district's $99.4 million ULT bonds outstanding (pre-refunding).

The Rating Outlook is Stable.

SECURITY

The bonds are payable from an unlimited tax levied against all taxable property within the district. The PSF guaranty applies to all outstanding bonds of the district except the series 2006 ULT school building and refunding bonds.

KEY RATING DRIVERS

SOUND FINANCIAL PROFILE: Solid general fund reserves reflect conservative budgeting and cost management, supplemented by voters' approval of a permanent maintenance and operations (M&O) tax rate increase.

STEADY REGIONAL ECONOMIC GROWTH; WEAK INCOME LEVELS: Residential and commercial development continues to expand westward towards the district from El Paso, creating healthy gains in taxable assessed valuation (TAV). Nonetheless, wealth indicators remain below average and the unemployment rate is higher than the state.

ABOVE-AVERAGE DEBT: Overall debt levels are high and will be pressured by ongoing facility needs based on current enrollment projections. A moderate debt service tax rate provides adequate borrowing capacity over the medium term.

RATING SENSITIVITIES

ADEQUATE RESERVES AMIDST GROWTH PRESSURES: Failure to maintain structural balance and adequate reserves as the district faces growing enrollment pressures could lead to negative rating action.

CREDIT PROFILE

The district is located in the less developed northwestern corner of El Paso County (GO bonds rated 'AA' by Fitch/ Stable Outlook), serving a population of about 27,700 over 67 square miles that include portions of the City of El Paso and neighboring rural areas.

ENROLLMENT EXPECTED TO RESUME GROWTH SOON

The district receives residual enrollment growth from El Paso and nearby Santa Teresa, New Mexico, a significant commercial hub and port of entry into Juarez, Mexico. Officials expect the current average daily attendance (ADA) of 5,470 students to grow notably in the next five years due to the availability of affordable land, the extensive transportation network traversing the district, and master planned development projects currently underway.

In fact, ADA has flattened in recent years and actually declined unexpectedly by 2.3% in fiscal 2015. ADA declines were recorded in most area school districts due to the fading impact of Ft. Bliss' expansion in 2011 - 2012. The district also attributes this trend to a modest number of student transfers to adjacent El Paso Independent School District, which recently approved open enrollment and has schools in closer proximity to the district's growth corridor.

Year-to-date ADA for fiscal 2016 is modestly above the previous year's level and management expects ADA will resume growth with the recent opening of a new district school in the affected area and the ramp up of new home construction district-wide. The district reports that 8,374 homes are planned within the district over the next three to five years. However, management is conservatively projecting a modest 1.5% annual growth in ADA for the next several years in order to mitigate the potential for state aid overpayments.

TAX BASE POISED FOR CONTINUED GROWTH

The district's $2.2 billion tax base increased more than 6% annually between fiscal 2009 and 2014, reflecting the economic impact of the $5 billion Fort Bliss military base expansion and an influx of international investment that muted the effects of the recession. Expectations for additional near term growth are supported by extensive commercial and residential development currently underway.

Taxable values declined by a modest 1.4% in fiscal 2015 due to a legal challenge from its largest taxpayer, the El Paso Outlet Center Holding LLC. The outlet center successfully sued the county appraisal district to reduce its TAV by a large 33%, reducing its percentage of total TAV to 3.6% from 5.3%. Two other major district taxpayers, Hoover, Inc. (1.6% of TAV) and Leviton MFG Co Inc. (1% of TAV), both closed their manufacturing plants due to relocations overseas. These losses were offset by a 5.7% gain in fiscal 2016 attributed to continued residential building and commercial projects, which include a new wing at the outlet center. A $120 million teaching hospital is currently under construction and is scheduled for completion in January 2016. The hospital's full taxable value will be reflected in the tax rolls by fiscal 2018.

IHS Global Insights points to the region's younger-than-average population as a strength, supporting strong service sector growth. However, relatively low skill levels limit high-paying job growth. The MSA's latest unemployment rate of 5.1% for Sept. 2015 is improved from the prior year's rate of 6.3%, but still above the averages for the state (4.4%) and the nation (4.9%) for the same period.

SOUND FINANCIAL PROFILE

The district generally outperforms the budget and maintains strong general fund balance levels. State funding comprises 60% of total revenues, a function of enrollment growth and the district's property poor classification. After a shift in the district's fiscal year boosted the district's financial cushion in fiscal 2011, the district posted two consecutive years of general fund net surpluses (after transfers), aided by conservative budgeting, recurring cost savings, and additional revenue associated with the M&O tax rate increase to $1.17 from $1.04 per $100 TAV. The M&O tax rate is at the statutory cap, limiting further ad valorem tax revenue growth aside from new construction and appreciation.

In fiscal 2014, the district's audit posted a large $6.8 million (11.5% of spending) general fund net deficit (after transfers) due mostly to $4.2 million of pay-go capital outlays and a $1.2 million property tax rebate. The deficit was also due to a state aid decline of $2.7 million or 8.7%, resulting from the state's one-year lag in recognizing the reappraisal loss. Despite the drawdown, the unrestricted general fund balance remained solid at $10.8 million or 18% of spending and transfers out. The district expects to make incremental progress in meeting its fund balance policy which was recently increased to 30% of budgeted expenditures from 20.5%.

The fiscal 2015 audit posted a modest net deficit of $433,000 (0.8% of spending). Net of $1.5 million in pay-go, the audit points to structural balance despite the unexpected decline in ADA. Although the district budgeted state aid revenues based on a large 4.9% gain in ADA, the district did not increase staff to that level and maintained its student to teacher ratio at the 22:1 maximum allowed by the state. A true-up of state aid revenues at fiscal year-end reallocated the overpayment of state aid, which the district had set aside. The true-up was partially netted against the restoration of the previous year's state aid decline.

The fiscal 2016 budget projects a $3 million net deficit based on conservative state aid revenue estimates and increases in contributions for health insurance premiums. The budget does not provide any salary hikes and includes the addition of only seven teachers for the new elementary school, as the bulk of its teaching staff was reallocated from existing campuses. Based on greater than budgeted ADA and continued cost controls, management now projects balanced results for fiscal year end.

ABOVE AVERAGE DEBT/CONTINUING CAPITAL NEEDS

The district's overall debt is above-average at $6,848 per capita and 8.2% of market value. However, due partly to a slow principal amortization rate (38% in 10 years), debt service carrying costs were low at 9.2% of governmental spending in fiscal 2015. Debt service costs decrease to 8.2% of governmental spending if adjusted for the current level of state support totaling 13% of debt service.

In May 2013, the district exhausted its 2011 bond authorization. The 2011 bond program was projected to bring the district's debt service tax rate to $0.41 per $100 of TAV, based on reasonable TAV and enrollment growth assumptions. The rate has climbed to only $0.36, and as a result the district retains adequate debt capacity in relation to the attorney general's tax rate cap of $0.50 for new debt issuance.

Fitch expects the district's overall debt ratios to remain elevated due to enrollment growth pressures and slow debt amortization. A facilities master plan, scheduled for completion in spring 2016, will guide the decision regarding the size of the next bond election -- planned in 2018 or 2019. Current school capacity is most pressured at the high school and elementary school levels, although the district reports that it has not been necessary to use portable classroom buildings.

AFFORDABLE PENSION BENEFITS

The district's pension liabilities are limited to its participation in the state pension plan administered by the Teachers Retirement System of Texas (TRS). The bulk of contributions are made by individual plan members and the state of Texas on behalf of the district, thus minimizing liability for the district. The system also offers other postemployment benefits (OPEB) to retirees.

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. However, school districts are susceptible to future funding changes by the state as evidenced by a new, relatively modest employer contribution requirement of 1.5% of salary effective fiscal 2015. At August 31, 2014 TRS reported a funding level of 80%, and funding was still satisfactory at 72% using a 7% investment return assumption.

Fitch views the district's limited pension and OPEB obligations as an offset to the high debt levels. Including debt service, pension and other post-employment benefit contributions, district payments on long-term liabilities were modest at 9.3% of governmental spending in fiscal 2015 (net of 13% state support for debt service).

TEXAS SCHOOL DISTRICT 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 consider any changes that include additional funding for schools and more local discretion over tax rates to be a credit positive.

Additional information is available at 'www.fitchratings.com'.

Fitch recently published an exposure draft of state and local government tax-supported criteria (Exposure Draft: U.S. Tax-Supported Rating Criteria, dated Sept. 10, 2015). The draft includes a number of proposed revisions to existing criteria. If applied in the proposed form, Fitch estimates the revised criteria would result in changes to fewer than 10% of existing tax-supported ratings. Fitch expects that final criteria will be approved and published by Jan. 20, 2016. Once approved, the criteria will be applied immediately to any new issue and surveillance rating review. Fitch anticipates the criteria to be applied to all ratings that fall under the criteria within a 12-month period from the final approval date.

In addition to the sources of information identified in the applicable criteria specified below, this action was informed by information from CreditScope, IHS Global Insight, and Zillow Group.

Applicable Criteria

Exposure Draft: U.S. Tax-Supported Rating Criteria (pub. 10 Sep 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869942

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

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=996226

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=996226

Endorsement Policy

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

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

Contacts

Fitch Ratings
Primary Analyst
Jose Acosta
Senior Director
+1-512-215-3726
Fitch Rating, Inc.
111 Congress Ste. 2010
Austin, TX 78701
or
Secondary Analyst
Rebecca Moses
Director
+1-512-215-3729
or
Committee Chairperson
Michael Rinaldi
Senior Director
+1-212-908-0833
or
Media Relations
Sandro Scenga, +1-212-908-0278
sandro.scenga@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Jose Acosta
Senior Director
+1-512-215-3726
Fitch Rating, Inc.
111 Congress Ste. 2010
Austin, TX 78701
or
Secondary Analyst
Rebecca Moses
Director
+1-512-215-3729
or
Committee Chairperson
Michael Rinaldi
Senior Director
+1-212-908-0833
or
Media Relations
Sandro Scenga, +1-212-908-0278
sandro.scenga@fitchratings.com