Fitch Affirms Edna ISD, TX ULT Bonds at 'AA-'; Outlook Stable

AUSTIN, Texas--()--Fitch has affirmed the following Edna Independent School District (ISD; the district), TX ratings at 'AA-':

--Issuer Default Rating (IDR);

--$18.4 million unlimited tax bonds (ULTs).

The Rating Outlook is Stable.

SECURITY

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

KEY RATING DRIVERS

The 'AA-' IDR and ULT rating reflects the district's modest long-term liability burden and superior operating performance, aided by ample expenditure flexibility and prudent revenue budgeting.

Economic Resource Base

Edna ISD sits approximately 90 miles southwest of Houston and 25 miles northeast of Victoria in Jackson County. The primary population center of this rural district is the city of Edna (2015 population of 5,792) and the district's enrollment totals approximately 1,560.

Revenue Framework: 'a' factor assessment

The district has realized robust revenue growth over the past 10 years at a rate in excess of U.S. GDP growth. The revenue impact of the cyclical contraction of the district's energy sector will be offset by additional state aid, leading Fitch to expect stable revenue growth in the medium term. It does not have the ability to independently raise revenues.

Expenditure Framework: 'aa' factor assessment

Fitch expects the pace of spending growth to be generally in line with revenue gains. Expenditure flexibility is derived from management's control over workforce costs and low carrying costs.

Long-Term Liability Burden: 'aaa' factor assessment

The liability burden is modest, comprised primarily of direct debt, and should remain low given the district's reliance on pay-go for its limited capital needs

Operating Performance: 'aaa' factor assessment

Fitch expects the district's financial flexibility to remain solid through a moderate economic downturn based on its ample financial reserves and solid expenditure flexibility.

RATING SENSITIVITIES

Shift in Fundamentals: The IDR and ULT bond ratings are sensitive to material change in the district's strong expenditure flexibility and prudent budgeting practices, which Fitch expects the district to maintain throughout economic cycles.

CREDIT PROFILE

This small district has a limited economy based predominantly in agriculture and oil and gas interests. The district's proximity to the Eagle Ford Shale, one of the largest shale oil and gas deposits in the U.S., spurred tax base, employment and enrollment gains within the district in recent years. Although mineral values account for less than 3% of the district's assessed value (AV), the 2013 addition of two natural gas liquids (NGL) processing plants substantially increased the district's concentration in the oil & gas sector.

The NGL processing plants (DCP Eagle and Flag City) increased AV by a large cumulative 45.7% in fiscal years 2014 and 2015. While portions of the plants' values will be abated for general fund taxing purposes over a 10-year period, the full values will be taxable for debt service, as allowed under state-authorized economic incentive agreements.

The NGL plants contribute to considerable tax base concentration of 37% among the top 10 payers in fiscal 2016, up from a moderate 11% in fiscal 2013. DCP and Flag City now account for 16% and 8%, respectively, of the tax base. DCP Eagle's parent company, DCP Midstream, LLC is rated 'BBB-' by Fitch. Industry concentration is high with oil and gas companies as eight of the top 10 taxpayers.

After flattening in fiscal 2016, AV declined by a moderate 7.2% in fiscal 2017 due primarily to reassessment losses in the energy sector. AV losses related to the NGL plants were the result of declines in oil and gas prices which affect the production levels of NGLs, a byproduct of gas and crude oil wells. This credit concern is partially offset by the diversity of the plants' end users, composed of oil refineries (upstream users) and petrochemical and plastics companies (downstream users) which benefit under opposite trajectories in oil & gas prices. New NGL processing plants are also considerably more efficient than older plants and should generate profit margins over wider oil & gas price swings, enhancing their long-term sustainability.

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 vast 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 that varies from district to district. In fiscal 2015, the district received 50% of its total general fund revenues from state sources, followed by local property taxes (45%).The district conservatively budgets average daily attendance (ADA) at a level modestly below the previous year's ADA.

For the 10-year period through fiscal 2015, the district's general fund revenues grew by a CAGR of 3.7%, above the pace of inflation and the growth rate of U.S. GDP. The pace of revenue growth, which is driven in part by enrollment, may flatten or decline modestly in the near term due to contraction of the district's energy sector but Fitch expects medium-term revenue growth will rebound to the pace of inflation or higher. Budget exposure to taxable AV volatility is mitigated by the state's target revenue funding system, which offsets declines in local revenue with additional state aid, albeit with a one-year lag.

Edna ISD's maintenance and operations (M&O) tax rate of $1.04 per $100 AV is at the statutory cap above which voter approval is required, leaving it with no independent revenue-raising flexibility. The district does not have plans to seek voter approval of an increase in its M&O tax rate.

Expenditure Framework

Instructional costs account for 56% of fiscal 2015 operating expenditures (net of capital outlays), which Fitch expects to grow in line with revenues, along with the district's other operating costs.

The district's pace of expenditure growth is expected to be generally in line with revenue growth given its modestly growing enrollment base and associated lack of growth pressures.

The district's expenditure flexibility is derived from discretion over its workforce costs and modest carrying costs, which are low at 8.3% of fiscal 2015 spending, and comprise primarily debt service. Fitch expects carrying costs to remain modest based on the district's limited debt plans and the assumed ongoing state funding for the vast majority of employer pension and OPEB contributions. The district's 10-year principal amortization is below average at 32%.

Long-Term Liability Burden

The district's long-term liability burden is modest at 8.4% of personal income and is comprised mostly of direct debt. The district's remaining capital needs are modest and will be funded on a pay-as-you-go basis, leading Fitch to expect the liability burden to remain modest.

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 on behalf of school districts, except for small amounts that state statute requires districts to assume.

Operating Performance

Fitch expects Edna ISD to retain ample financial flexibility in a moderate economic downturn based on its strong expenditure flexibility and robust financial cushion.

The district has accumulated large reserves during the current economic recovery despite cuts in state aid revenues in previous years. The district uses these accumulated balances for pay-go capital spending, contributing to reported deficits in both fiscal 2015 and fiscal 2016. Reserves remain high at a projected $6.9 million, or 52% of budgeted spending, as of the end of fiscal 2016. The fiscal 2017 budget is balanced, funds modest pay hikes, and projects a modest decline in ADA. Current ADA reflects a modest increase over budgeted levels, leading Fitch to expect better than budgeted results.

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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https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1015670

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1015670

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https://www.fitchratings.com/regulatory

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Contacts

Fitch Ratings
Primary Analyst
Jose Acosta
Senior Director
+1-512-215-3726
Fitch Ratings, Inc.
111 Congress Avenue
Austin, TX 78701
or
Secondary Analyst
Steve Murray
Senior Director
+1-512-215-3729
or
Committee Chairperson
Karen Krop
Senior Director
+1-212-908-0661
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Jose Acosta
Senior Director
+1-512-215-3726
Fitch Ratings, Inc.
111 Congress Avenue
Austin, TX 78701
or
Secondary Analyst
Steve Murray
Senior Director
+1-512-215-3729
or
Committee Chairperson
Karen Krop
Senior Director
+1-212-908-0661
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com