AUSTIN, Texas--(BUSINESS WIRE)--Fitch Ratings has affirmed the following Denton ISD ratings at 'AA':
--Issuer Default Rating (IDR);
--Approximately $839 million in outstanding unlimited tax (ULT) bonds.
The Rating Outlook is Stable.
The bonds are payable from an unlimited property tax (ad valorem) pledge levied against all taxable property within the district.
KEY RATING DRIVERS
The 'AA' IDR and ULT bond rating reflect the district's superior financial resilience, aided by solid expenditure flexibility, limited historical revenue volatility, and sound operating reserves, which help to offset its very limited revenue raising ability. The district's somewhat elevated debt burden is driven by rapid enrollment growth, which is expected to remain in the moderate range. Fitch believes the long-term liability burden should remain aligned with the area's pace of economic and population expansion.
Economic Resource Base
The district is located approximately 40 miles northwest of downtown Dallas. It encompasses the city of Denton (GOs rated 'AA+' by Fitch) and much of the Denton County with about 182,000 residents. Continued population and enrollment growth is driven by a growing regional economy. Educational attainment and income/wealth metrics are generally above average.
Revenue Framework: 'a' factor assessment
Fitch believes revenue growth prospects are strong, consistent with historical trends, given the likelihood of further enrollment and economic growth. District tax rates are limited by state law according to the school funding system.
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. Sound expenditure flexibility is a result of the district's ability to adjust its labor costs if needed as well as moderate carrying costs.
Long-Term Liability Burden: 'a' factor assessment
The long-term liability burden is moderately elevated. Fitch expects the likely growth in the area's long-term liabilities will be balanced against additional economic expansion and remain consistent with an 'a' assessment.
Operating Performance: 'aaa' factor assessment
Fitch believes the district's operating cushion would be more than adequate for an 'aaa' financial resilience assessment in a moderate economic decline, with the district maintaining a high level of fundamental flexibility throughout the economic cycle.
Growth-related Pressures: The maintenance of financial flexibility through conservative budgeting is a key mitigant to credit concerns over the district's large debt load and ongoing growth-related spending pressure.
District residents participate in a strong regional economy given proximity to the robust Dallas-Fort Worth (DFW) metropolitan statistical area (MSA) economy and diverse employment market. This proximity and the access provided by newly expanded toll roads and major highways as well as air and rail transportation have attracted a variety of industries and businesses to the area. An expanding service sector and manufacturing development also continue to diversify the district's mostly residential tax base. Education and health services top the list of major area employers, which provided a measure of stability during the recession. The University of North Texas and Texas Woman's University are located in the city of Denton. Area employment indicators remain strong, evidenced by continuing employment and labor force gains in the city and county.
Population and enrollment gains, which were significant over the past decade, are also continuing, accompanied by strong tax base expansion. Taxable assessed valuation (TAV) gains have modestly outpaced enrollment growth historically. TAV grew on average by about 7% annually as compared to 5% enrollment growth in the 10-year period over fiscals 2005-2015. Further, strong TAV growth of 10% was realized in fiscal 2017. District enrollment totaled about 27,684 students in fiscal 2016. Actual student enrollment has remained largely on track with projections to date and the district's demographer projects a steady pace of 2%-3% annual student growth to continue over the near term. Fitch believes further population, enrollment, and TAV expansion over the medium to intermediate term is reasonable given ample developable land in this growing regional economy.
About 60% of the district's general operating revenues come from property taxes. 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). Third-party funding support for operations stems from the long-standing commitment of the state to fund K-12 education. This revenue stream remains susceptible to changes in local enrollment trends and recessionary pressures on state revenues.
Fitch believes growth prospects for revenues are strong given the likely continuation of current enrollment and TAV trends in a growing regional economy. Denton ISD's 6.6% average annual revenue growth exceeded the pace of U.S. GDP over the past 10 years ending in fiscal 2015. This trend is largely a result of the district's historically steady and relatively aligned pace of TAV and enrollment expansion as well as its ability to capture year-over-year tax base gains due to a one-year lag in state aid adjustments. Revenue growth also reflects periodic state funding adjustments.
The district has almost no ability to independently raise its operating revenues. Per state statute, the district cannot increase its operating property tax levy ($1.04 per $100 TAV) unless it receives voter approval.
Instruction is the primary purpose of the institution, consuming about 67% of operational spending in fiscal 2016. Moderate annual enrollment gains are anticipated, and Fitch expects the expected strong pace of revenue growth will lead spending and remain more or less aligned over time.
The district has demonstrated its ability to adjust staffing and class sizes in order to control key expenditure items in times of fiscal stress without affecting its educational goals. This is tempered by the district's need to maintain a competitive salary structure in order to recruit and retain highly educated professionals. Nonetheless, management's legal control of labor costs and headcount remains strong.
Fixed carrying costs (the combination of total annual debt service, the contractually required annual pension funding amount, and the annual actual spending for other post-employment benefits [OPEB] net of state support) consumed about 15% of fiscal 2016 governmental spending and do not pressure the district's operating budget. Fitch expects these fixed costs will slowly rise going forward as a result of future debt plans, likely necessitated by further enrollment growth. However, these costs should remain moderate and in line with the 'aa' assessment based on proportional growth in the district's operations and debt service as well as low retiree costs that reflect primary state funding of this expense.
Long-Term Liability Burden
The district's overall debt and net pension liability is moderately elevated at an estimated 25% of personal income. About half of the overall burden is derived from the district's direct debt (roughly $839 million) and principal amortization is slow at about 25% retired in 10 years. Fitch expects the likely increases in the overall liability burden over time will be balanced against further population and income gains, remaining consistent with an 'a' assessment. The assessment assumes ongoing state funding for the majority of employer pension and OPEB contributions.
Expectations of further TAV gains in excess of enrollment should also improve the district's currently limited capital and debt flexibility. The debt service tax rate is at the statutory, new money cap of $0.50 per $100 TAV. The district has exhausted its outstanding bond authorization, which will fund the construction of three additional school facilities planned to open over fiscals 2018 - 2020. Management funds most of its non-facility capital needs (buses, technology, etc.) with pay-as-you-go capital spending. The district's practice of early debt retirement also contributes to moderating its liability burden. Current plans include a fiscal 2017 cash defeasance of $7 million in outstanding ULT bonds (less than 1% of total direct debt).
The district participates in the Texas Teachers Retirement System (TRS), a cost-sharing, multiple-employer plan for which the state provides the bulk of the employer's (the district) annual pension contribution. Recent reforms have lowered benefits and increased statutory contributions in order to improve plan sustainability over time.
Under GASB 67 and 68, the district reports its share of the TRS net pension liability (NPL) at $59.8 million in fiscal 2016, with fiduciary assets covering 78.4% of total pension liabilities at the plan's 8% investment rate assumption (approximately 71% based on a more conservative 7% investment rate assumption). The NPL adjusted for a 7% interest rate assumption remains small at less than 1% of personal income. The district also provides OPEB through the state-run, post-employment benefit healthcare plan.
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 'a' assessment given how small the pension liability is relative to overall debt. Like all Texas school districts, Denton ISD 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 fiscal 2015.
Fitch believes Denton ISD would utilize a combination of its expenditure flexibility and currently sound reserves to adjust to a moderate economic downturn and maintain a high level of financial flexibility throughout the economic cycle. The district has historically preserved operational balance while making periodic draws on fund balance for non-facility capital needs.
Management's generally conservative budget assumptions have historically produced a trend of net operating surpluses and allowed the district to address its growth needs while building financial flexibility during periods of economic recovery. Unreserved/unrestricted general fund reserves have consistently remained comfortably above district policy levels (unassigned reserves of no less than 15% of general fund spending and total general fund reserves at no less than 25%).
Fiscal 2016 results once again improved upon budget. The year's modest operating surplus provided an offset to the approximately $8 million in one-time capital spending. Unrestricted reserves were preserved at $81.4 million or 35.5% of spending at fiscal 2016 year-end. The $235 million fiscal 2017 budget anticipates modest use of reserves (roughly $8 million or 3.4% of spending), primarily for one-time costs associated with the opening of two new schools. Although a portion of the year's modest imbalance is due to recurring costs, the district's established trend of conservative fiscal practices and stable finances suggest to Fitch that these additional operating costs will be absorbed successfully.
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.
U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)
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