Fitch Rates Rio Grande City CISD, TX ULT Rfdg Bonds 'AAA' PSF/'A+' Underlying; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned a 'AAA' rating to the following Rio Grande City Consolidated Independent School District, TX unlimited tax (ULT) refunding bonds:

-- $8.6 million ULT refunding bonds, series 2016.

The bonds are scheduled for negotiated sale the week of Nov. 28. Proceeds will be used to refund a portion of the district's outstanding ULT bonds for debt service savings.

The 'AAA' long-term rating for the bonds is based on a guaranty provided by the Texas Permanent School Fund (PSF), whose bond guaranty program is rated 'AAA' by Fitch.

In addition, Fitch has assigned an underlying rating of 'A+' to the bonds and affirmed the outstanding underlying rating on $109.2 million in unlimited tax obligations (pre-refunding) and the district's Long-Term Issuer Default Rating (IDR) at 'A+.'

The Rating Outlook is Stable.

SECURITY

An unlimited property tax levied against all taxable property within Rio Grande City Consolidated Independent School District and further secured by the Texas PSF bond guarantee program, rated 'AAA' by Fitch.(For more information on the Texas PSF, see 'Fitch Affirms Texas PSF Rating at 'AAA'; Outlook Stable' dated Aug. 5, 2015).

KEY RATING DRIVERS

The 'A+' IDR and unlimited tax bond rating reflects the district's solid expenditure flexibility and revenue growth prospects, a moderate long-term liability burden, and adequate gap-closing ability. An economic concentration in the oil and gas exploration sector is somewhat mitigated by wind energy development resulting in some diversity among the district's top 10 taxpayers.

Economic Resource Base

The district is located along the U.S.-Mexico border in Starr County. It is large at approximately 417 square miles and sparsely populated at an estimated 2015 population of approximately 38,000. The area's economy is largely based on agriculture and oil and gas production; however, recent development in the wind power industry has provided some diversity. District income and wealth metrics are well below state and U.S. averages, typical of many Texas-border communities. Enrollment has generally been flat to slightly declining over the past five years, with approximately 10,884 students in fiscal 2016. Future growth is expected to stabilize given some migration into the area and relatively limited competition from charter or other educational facilities.

Revenue Framework: 'a' factor assessment

A combination of local property taxes and state aid supports district operations. The district has realized strong revenue growth over the past 10 years at a rate in excess of inflation and U.S. GDP gains. Fitch expects revenue growth prospects to continue to be solid, based on expectations for continued enrollment growth and demographic trends. The district's independent legal ability to raise revenues is limited by state law.

Expenditure Framework: 'aa' factor assessment

Enrollment is a key driver of both revenue and expenditure trends, which should keep the pace of spending generally aligned with revenues over time. Expenditure flexibility is derived from management's control over workforce costs and low carrying costs, which also reflects state support for over half of the district's debt service costs.

Long-Term Liability Burden: 'aa' factor assessment

The long-term liability burden is moderate and Fitch expects it to remain so given a lack of new debt plans. Retiree benefit obligations do not represent a significant burden.

Operating Performance: 'aa' factor assessment

Fitch expects the district's operating cushion will remain adequate and in line with the 'aa' assessment in a moderate economic decline, underpinned by its solid expenditure flexibility and satisfactory reserves. Structural deficits are easing, and management appears committed to restoring reserves.

RATING SENSITIVITIES

Financial Flexibility: The rating is sensitive to the district's ability to maintain an adequate level of operating flexibility in light of a controlled revenue environment (pursuant to the state's funding formula). An inability to restore structural budgetary balance would erode operating flexibility and could pressure the rating.

CREDIT PROFILE

Concentration and volatility in the district's property tax base are results of the outsized impact of the energy sector and mineral values; this lack of diversity adds a measure of risk to the district. Taxable assessed value (TAV) concentration is high, with the 10 largest taxpayers accounting for about 50% of fiscal 2017 TAV.

Partially mitigating this concentration is significant wind energy development taking place within the region. As a result, the district's TAV has experienced exceptionally strong growth over the past two years; fiscal 2017 TAV of $1.5 billion is an increase of 15% over the prior year, following growth of 19% in fiscal 2016. This growth is largely due to the addition of Los Vientos Windpower III, IV and V (Duke Energy Renewables Wind, LLC), which together comprise about 37% of the district's fiscal 2017 TAV. This growth provides some diversity, but with additional taxpayer concentration, amongst the oil and gas sector taxpayers and some stability against fluctuating mineral values.

Enrollment projections for the 2016/2017 school year forecast 11,229 students, which would be a 3% increase over the prior year. A new charter school is set for a soft, limited opening in 2017. While the district expects to lose some students to this charter school, they see traditional school enrollment as growing 1% to 2% over the longer-term due to the migration of families into the area and the relative remoteness of the district and thus limited risk of competition from other educational facilities. Fitch believes the forecast is feasible, and at the low end would expect to see enrollment growth as generally holding steady over the medium term.

Revenue Framework

Funding for public schools in Texas is provided by a combination of local (property tax), state and federal resources. The state budgets the majority of instructional activity through the Foundation School Program (FSP), which uses a statutory formula to allocate school aid taking into account each district's property taxes, projected enrollment, and amounts appropriated by the legislature in the biennial budget process. The majority of districts are funded using a target revenue approach, whereby the combination of local and state funding for operations meets a predetermined per pupil amount (which varies from district to district). In fiscal 2015, general fund revenues were approximately 11% property tax and 78% state sources.

Historical revenue growth has been robust, above that of U.S. GDP growth. Fitch believes this trend may soften somewhat in the near- to intermediate-term, as the enrollment base is projected to grow at a modest 1%-2% and the district may lose some students to a new charter school slated to open next year.

The district's independent legal ability to raise revenues is limited. This district's fiscal 2017 maintenance and operations (M&O) tax rate of $1.17 per $100 TAV is at the statutory ceiling. The district levies a separate debt service tax rate of $0.28 per $100 TAV, well below the statutory cap of $0.50 per $100 TAV for new debt issuances.

The district's wind power property is subject to abatement (for maintenance and operating purposes) for several years. Under these agreements, the property owners (Duke Energy Renewables Wind, LLC and Hidalgo Wind Farm, LLC) are required to make supplemental payments to the district over the abatement period. These payments as well as additional wind projects are expected to partially offset the loss of the projects on the tax roll and contribute to stability of the tax base in the next several years.

Expenditure Framework

The district spends the majority of its operating budget on instruction, consistent with most school districts.

Fitch expects the natural pace of spending growth to remain commensurate with revenues absent policy action, given expected enrollment growth and accompanying capital needs.

The district's expenditure flexibility is derived from low carrying costs and discretion over its workforce. The district's carrying costs for debt, pensions and other post-employment benefits (OPEB) equaled a low 5% of 2015 governmental expenditures. Fitch expects the fixed-cost burden to remain low based on the assumed ongoing state support of debt service and pension obligations, as well as the district's lack of major capital or debt needs in the medium term. Areas of flexibility are primarily instruction, including class sizes (the district has availed itself of class size waivers in the past), staffing patterns, and teacher salaries. The district primarily operates with individual one or two-year contracts and does not engage in collective bargaining.

Long-Term Liability Burden

The district's long-term liability burden is in the moderate range at about 15% of personal income and is comprised predominately of the district's direct debt, in addition to a modest net pension liability. The district currently has no capacity concerns at its schools, and management stated its 18 facilities are in good condition. As such, the district does not have any current debt plans.

The district participates in the Texas Teachers Retirement System (TRS), a cost-sharing multiple employer pension system. Under GASB 67 and 68 reporting, TRS's assets covered 83.3% of liabilities as of fiscal 2015, a ratio that falls to a Fitch-estimated 75% using a more conservative 7% return assumption. The state assumes the majority of TRS employer contributions and net pension liability (NPL) on behalf of school districts, except for small amounts that state statute requires districts to assume.

Participants' required pension contributions are based on a statutory formula that consistently falls short of the actuarially-determined amount. Fitch therefore expects there will be modest growth in the NPL even if investment returns meet assumed rates, although not outside of expectations for the 'aa' assessment given how small the pension liability is relative to overall debt. Like all Texas school districts, Rio Grande City CISD is vulnerable to future policy changes that shift more of the contributions and liabilities onto districts, as evidenced by a relatively modest 1.5% of salary contribution requirement effective in fiscal 2015.

Operating Performance

Fitch's three year scenario revenue estimate generated by Fitch's analytical sensitivity tool (FAST) indicates that in an unaddressed scenario associated with a moderate economic downturn, revenue declines would lead to fiscal stress resulting in significant draw-down of reserves. However, Fitch believes the district would utilize a combination of its budgetary flexibility and currently sound reserves to adjust to a moderate recessionary revenue decline. Management indicates an ability to cut departmental spending or defer capital outlay (as it has done in the past) during a revenue downturn to maintain a sound level of financial flexibility.

The district maintained reserves in excess of its informal two months of spending target for the five years prior to fiscal 2013 in anticipation of drawdowns in fiscal 2013 and fiscal 2014 to fund a new high school. Unrestricted reserves fell just below the district's two-month fund balance target in fiscal 2014. Fiscal 2015 results came in significantly better than budgeted due to positive variances on both the revenue and expenditure side - primarily through reductions in facility maintenance, administration, and capital outlay spending. Unrestricted reserves were equal to approximately 14% (about 51 days) of spending in fiscal 2015. The deficit in fiscal 2015 (approximately $538,293 or less than 1% of spending) was largely related to wage and salary adjustments.

The district anticipates outperforming its planned fiscal 2016 budget deficit of $2.9 million, with either a modest loss or breakeven results. This is due to cost savings and expected annual supplemental revenues pursuant to its chapter 313 agreements with Duke Energy Renewables Wind, LLC. The district's fiscal 2016 budget reflected a draw on fund balance as a result of the teacher salary increases implemented in fiscal 2015 that were not funded through an increase in operating revenues. Primarily because of this salary increase, the district is budgeting for structural imbalance and draws on fund balance through fiscal 2017.

Similar to fiscal 2016, the fiscal 2017 budget reflects a $2.3 million general fund operating deficit (approximately 2% of spending) although management anticipates performing better than budget which Fitch believes is feasible given the district's recent past of outperforming budget. Although the fiscal 2015 unrestricted reserves remain below the district's informal target policy, management appears committed to reaching this target over the next several years.

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

In addition to the sources of information identified in the applicable criteria specified below, this action was informed by information from Lumesis and InvestorTools.

Applicable Criteria

U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)

https://www.fitchratings.com/site/re/879478

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Contacts

Fitch Ratings
Primary Analyst
Nicole Wood
Director
+1-212-908-0735
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Steve Murray
Senior Director
+1-512-215-3729
or
Committee Chairperson
Marcy Block
Senior Director
+1-212-908-0239
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Nicole Wood
Director
+1-212-908-0735
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Steve Murray
Senior Director
+1-512-215-3729
or
Committee Chairperson
Marcy Block
Senior Director
+1-212-908-0239
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com