Fitch Rates Denver School Dist. No. 1, CO's GO Bonds 'AA+'; Outlook Stable

AUSTIN, Texas--()--Fitch Ratings has assigned a 'AA+' rating to the following Denver School District No.1, CO bonds:

--$142.3 million general obligation (GO) refunding bonds, series 2016.

The bonds are scheduled to price via negotiation during the week of April 25. Bond proceeds will be used to refund outstanding debt for interest savings.

In addition, Fitch has affirmed the following GO bonds and certificates of participation (COPs):

--$1.2 billion GO bonds at 'AA+';

--$1.03 billion COPs at 'AA'.

SECURITY

The GO bonds are payable from an annual unlimited property tax levy. The COPs are secured by base rental payments made by the district to the Denver School Facilities Leasing Corporation for use of school facilities, subject to annual appropriation.

KEY RATING DRIVERS

LARGE, GROWING ECONOMIC BASE: Denver's economy is fundamentally sound and diverse, serving as the hub of commerce for a large 10-county metropolitan area and as the seat of state government. Steady annual gains in jobs, personal income, and home values, point to positive economic conditions.

GROWTH PRESSURES REMAIN: Recessionary state aid cuts have yet to be restored and continue to pressure the district's budget although revenue enhancements are expected to assist in maintaining adequate operating reserves. Expenditure flexibility is a key consideration given the strong growth in enrollment in recent years. Enrollment growth pressures are easing slightly but are expected to persist, requiring continued attention to additional cost efficiencies amidst new school openings and expansions.

OVERALL DEBT SHOULD REMAIN AFFORDABLE: Overall debt levels have moderated materially due to the recent assessed value (AV) surge, creating capacity for future bond propositions needed for the district's facility improvement needs. Fitch expects carrying costs for long term liabilities to remain an affordable part of the budget, partly due to slow debt amortization and reduced pension funding resulting from statutory changes in contribution levels.

PENSION METRICS SOUND BUT UNFUNDED LIABILITY POISED TO GROW: The district pension's asset to liability ratio is sound but expected to decline over the medium term due to statutory changes to its contribution levels.

APPROPRIATION RISK; SOUND LEGALS: The one notch rating distinction on the COPs reflects appropriation risk. Legal provisions for the COPs are sound and include a mortgage interest in essential assets of the district.

FAVORABLE OPEB FUNDING: The district's OPEB obligations have been funded on an actuarial basis since 2005, well ahead of most school districts and municipalities.

RATING SENSITIVITIES

ADEQUATE CUSHION: The rating is sensitive to maintenance of a solid financial cushion in light of unrestored state aid cuts and growth in related debt needs.

CREDIT PROFILE

FAVORABLE LONG-TERM ECONOMIC PROSPECTS

The district is coterminous with the city and county of Denver (unlimited tax GOs rated 'AAA' by Fitch), a diverse economic hub of a 10-county MSA and the capital of Colorado. After posting recessionary job losses in 2009-2010, the district has averaged solid employment gains annually. Coupled with modest labor force gains, the unemployment rate has declined annually and averaged 3.1% in January 2016, below both the state (3.2%) and nation (5.3%).

New construction activity is robust. Ongoing redevelopment throughout the city and substantial public and private investment in the downtown area, including the massive Denver Union Station project, are expected to benefit the district's medium-term economic prospects. Homebuilding at the expansive Stapleton redevelopment area is fueling the majority of the district's recent enrollment growth.

ENROLLMENT PRESSURES EASED BY CHARTER SCHOOLS

Denver School District No. 1 is the fastest growing large district in Colorado. At a funded pupil count (FPC) of 85,600 in fiscal 2016, the district's FPC has grown by a compound annual average of 3.3% over the last five years. Charter school enrollment represents nearly 20% of the total funded pupil count. Fitch does not consider this a financial pressure for the district based on the collaborative relationships that promote the use of shared campuses to facilitate enrollment growth, and the sharing of facility operating costs.

SURGE IN TAX BASE REFLECTS REASSESSMENT GAINS

Reappraisals on the district's diverse property base fueled a very large 25.8% AV gain in fiscal 2016, increasing AV per capita to a robust $143,000. District home sale prices averaged $317,000 in February 2016, a nearly 8% gain from the year prior, suggesting additional strong reappraisal gains will occur in fiscal 2018. The district projection of a 4% gain is considered conservative by Fitch given recent performance and investment activity.

The district's revenue base benefits from voter support for permanent fixed dollar mill levy overrides approved in 1988, 1998, 2003 and 2005. Voters went one step further in 2012 approving by a 68% margin a fixed millage override which has both upside and downside revenue potential as AV fluctuates. The permanent 4.86 mill levy override will raise $69.9 million in property taxes in fiscal 2016, a $15 million increase from fiscal 2015 due to the surge in AV.

HIGH COMMUNITY SUPPORT; ELEVATED OVERALL DEBT LEVELS

The district does not have approval for future debt issuance, having exhausted the $466 million GO bond authorization approved by a high 64% of voters in November 2012 for district-wide improvements, renovations, new construction, and technology updates. The current overall debt burden, inclusive of $1.03 billion in outstanding COPs, has declined from over 5% to a moderate 3.8% of full value due to the surge in AV. The overall debt burden remains elevated on a per capita basis at $5,444.

The district's GO principal pay-out rate is average with 55% maturing in 10 years. The pay-out rate for the COPs is very slow at 27% in 10 years, resulting in a combined pay-out rate of 42% in 10 years. A citizens' advisory bond council is currently reviewing the district's facility needs which may serve as the basis for a GO bond proposition this fall. It is management's goal to fund the next authorization within the current mill levy, potentially leading to a bond proposition of $470 million to $570 million.

STABILIZED FINANCES; GROWTH PRESSURES REMAIN

The district's general fund, which is comprised of an operating fund, a preschool fund, various O&M levy override funds, and a general projects fund, accumulated solid balances post-recession through prudent budgeting despite state aid cuts and AV declines. The accumulation of such reserves is intended to fund short-term costs for both operations and one-time expenditures for curriculum adoption and assumes state aid cuts will not be restored. Fitch expects reserves to be reduced to a lower but steady state by fiscal 2017. Upon the spend down of accumulated reserves, the maintenance of a solid financial cushion will be key as the district faces growth related debt needs and rising carrying costs.

The fiscal 2015 audit posted balanced results despite a budgeted draw down of $16 million (2% of spending), half of which was for one-time expenditures for curriculum adoption. The financial cushion, comprised of the unrestricted fund balance and the 3% emergency reserve, totaled $105.7 million or a solid 12.8% of spending.

The fiscal 2016 budget was adopted with a general fund drawdown of $9.5 million (1.1% of spending) due to $8.5 million in additional curriculum adoption outlays. Due to lower than budgeted FPC growth (1.8% actual vs 2.9% budgeted), the budget was amended to reflect a higher draw down of $14.7 million (1.7% of spending) as less state aid will be received. In this worst case scenario, the projected financial cushion totals $91 million or 10.8% of spending but is likely to be higher due to $21 million in appropriated site-based reserves (20%-30% of which are typically not expended).

The district foresees continued operating pressure and projects additional, albeit declining, fund balance draw-downs through fiscal 2017 due to state aid appropriations that remain below formula. State aid for the district is $94 million (a large 12% of fiscal 2016 general fund spending) below the amount prescribed by the funding formula. Management's preliminary projections for the fiscal 2017 budget includes a draw-down of up to $7 million (0.9% of spending) mostly due to expenditures for curriculum adoption. Such expenditures are projected at the same level ($6 million) through fiscal 2019. Along with the GO bond proposition, the district is also considering a ballot proposition for an O&M levy override in November 2016 to enhance its revenue base.

The district adopted a formal 15% unassigned fund balance policy in fiscal 2012 although district management does not expect to reach this target in the near term. However, the district does maintain a near-term minimum fund balance goal of 10%. Fitch believes the effective financial cushion (which includes the restricted 3% emergency reserve) at 12.8% of spending is currently at an adequate level.

PENSION FUNDING DECLINE

On Jan. 1, 2010 all employees of the district became members of the Public Employee Retirement Association (PERA) as a result of its merger with the Denver Public Schools Retirement System (DPSRS). PERA is a cost-sharing multiple employer defined benefit plan but it administers DPSRS as a single-employer plan with its assets, liabilities, and obligations separate and distinct from the other schools within PERA. The district has $939 million in outstanding COPs that were issued to fund its unfunded actuarially accrued liability (UAAL). Under GASB 67 and 68, DPSRS's assets cover 83.9% of its liabilities as of Dec. 31, 2014, a ratio that falls to 79.6% using Fitch's more conservative 7% rate of return assumption. Contributions are determined by state statute, rather than actuarially and historically have fallen short of the actuarially-recommended level.

Per statute, a five-year true-up calculation lowered DPSRS' contribution rate from 13.75% of payroll to 10.15% as of Jan. 1, 2015. The true-up is designed to assure that both plans' UAAL to payroll ratios are equal by Dec. 31, 2039. The UAAL to payroll ratio of PERA's school division equaled 351% as of Dec. 31, 2014, compared to DPSRS' ratio of 114%. PERA's school division's assets cover its liabilities by a low 58% using Fitch's 7% rate of return assumption. The deliberate ramp up of DPSRS' UAAL to payroll ratio (and the resulting decline in assets to UAAL) is viewed negatively by Fitch. However, PERA's school division's assets to UAAL ratio is expected to improve over the long-term due to a revised benefit structure imposed for employees hired after Dec. 31, 2006. Fitch expects this may allow future five-year true-ups to stabilize or improve DPSRS' assets to liability ratio.

OPEB PROVIDED THROUGH TRUST; AFFORDABLE CARRYING COSTS

The district's OPEB benefits are also provided through PERA through a trust fund initially established by the district in 2005. As of July 1, 2014, the funded ratio for the OPEB trust is low at 17%, but Fitch views positively any level of OPEB pre-funding. The district has funded between 80%-108% of the annual required contribution (ARC) in fiscal years 2013-2015. Total carrying costs for debt service, pension, and OPEB declined to a low 13.2% of fiscal 2015 governmental spending (net of refunding debt service) from 15% the year prior due to the decline in statutory pension contributions. Fitch expects carrying costs to rise, with additional debt and a below average amortization rate, but stay affordable relative to budget.

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

Fitch recently published exposure drafts of state and local government tax-supported criteria (Exposure Draft: U.S. Tax-Supported Rating Criteria, dated Sept. 10, 2015 and

Exposure Draft: Incorporating Enhanced Recovery Prospects into U.S. Local Tax-Supported Ratings, dated Feb. 2, 2016). The drafts include a number of proposed revisions to existing criteria. If applied in the proposed form, Fitch estimates the revised criteria would result in changes to less than 10% of existing tax-supported ratings. Fitch expects that final criteria will be approved and published in the second quarter of 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 and Lumesis.

Applicable Criteria

Exposure Draft: Incorporating Enhanced Recovery Prospects into US Local Tax-Supported Ratings (pub. 02 Feb 2016)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=875108

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

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1002689

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Contacts

Fitch Ratings
Primary Analyst
Jose Acosta, +1-512-215-3726
Senior Director
Fitch Ratings, Inc.
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Rebecca Meyer, +1-512-215-3733
Director
or
Committee Chairperson
Marcy Block, +1-212-908-0239
Senior Director
or
Media Relations
Sandro Scenga, +1-212-908-0278 (New York)
sandro.scenga@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Jose Acosta, +1-512-215-3726
Senior Director
Fitch Ratings, Inc.
111 Congress Avenue, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Rebecca Meyer, +1-512-215-3733
Director
or
Committee Chairperson
Marcy Block, +1-212-908-0239
Senior Director
or
Media Relations
Sandro Scenga, +1-212-908-0278 (New York)
sandro.scenga@fitchratings.com