Fitch Rates Hidalgo ISD, TX’s ULT Rfdg Bonds ‘AAA’ PSF/’A-‘ Underlying; Outlook Positive

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Fitch Ratings has assigned a ‘AAA’ rating to the following Hidalgo Independent School District, Texas (Hidalgo ISD, or the district) unlimited tax (ULT) bonds:

–$4.9 million ULT refunding bonds, series 2016A;

–$2.5 million ULT refunding bonds, series 2016B.

The ‘AAA’ long-term rating on the bonds is based on a guaranty provided by the Texas Permanent School Fund (PSF), whose bond guaranty program is rated ‘AAA’ by Fitch. For additional information on the Texas PSF rating please see Fitch’s Aug. 5, 2015 press release, ‘Fitch Affirms Texas Permanent School Fund at ‘AAA’; Outlook Stable’, available at ‘www.fitchratings.com’.

The bonds are scheduled for sale February 1 via negotiation. Proceeds will be used to refund certain outstanding bonds of the district for interest-cost savings.

Fitch also assigns an ‘A-‘ underlying rating to the bonds.

The Rating Outlook on the underlying rating is Positive.

SECURITY

The bonds are payable from an unlimited ad valorem tax pledge levied against all taxable property within the district.

KEY RATING DRIVERS

IMPROVING FISCAL CUSHION: The Positive Outlook reflects Fitch’s view that the current budgeting and management practices will continue to build financial flexibility over the near term. District management has taken concerted action to improve liquidity and reserves following significant deterioration caused by fiscal mismanagement.

MANAGEABLE DEBT BURDEN: Overall debt levels are elevated though capital needs are minimal. Annual fixed charges for debt and retiree pension and healthcare costs are low after consideration of state support.

WEAKER ECONOMIC METRICS: The district’s economic base, part of the larger Rio Grande Valley economy, remains challenged and socioeconomic indicators are subpar. Taxable assessed valuation (TAV) grew modestly over the past three years, following two years of declines.

RATING SENSITIVITIES

IMPROVED FINANCIAL PERFORMANCE: Continued positive financial performance and further gains toward the reserve target would reflect commitment to restoring a sound fiscal cushion and likely lead to positive rating action.

CREDIT PROFILE

Hidalgo ISD is a small district located in the southernmost region of Texas on the Mexico border. The district encompasses 36 square miles and includes the city of Hidalgo (outstanding increment revenue and limited tax certificates of obligation rated ‘A-‘), and serves approximately 3,200 students.

FISCAL IMPROVEMENT ANTICIPATED

Unaudited results for fiscal 2015 point to a general fund surplus despite a payroll increase for employee salaries and health benefits. The district was able to direct a portion of its healthy operating surplus toward a number of facility repairs and replacements while adding a projected $97,000 to reserves.

The fiscal 2016 budget includes another pay hike of 3.5% and is essentially balanced. Officials anticipate that state revenue enhancements of approximately $500,000 will allow the district to achieve a moderate surplus at year-end and meet its fiscal 2018 target general fund balance of $5 million.

IMPROVED FUND POSITION

Hidalgo ISD’s general fund balance was restated to a negative $1.4 million in fiscal 2009 to correct for accounting mis-statements and mismanagement by prior staff. This negative position included a large payable to the capital projects fund for $3.5 million in 2008 bond proceeds that had been imprudently deposited into the general fund for operational cash flow. Fitch believes there is some risk related to a potential investigation regarding the misuse of bond proceeds if their taxability is questioned. However, Fitch anticipates that any cost to the district from such litigation would be manageable.

A new management team in fiscal 2010 took several key steps that have yielded structural budget balance, improved liquidity and fund balances, and eliminated the capital projects fund liability. Spending cuts in fiscals 2010-2012 offset lower attendance and a challenging state funding environment, and included layoffs, attrition, and departmental reductions. In addition, voters approved an operating tax rate increase to the state statutory cap of $1.17 per $100 of TAV, generating additional revenue beginning in fiscal 2011.

The resulting positive operating margins achieved in the last five fiscal years (2010-2014) improved the unrestricted general fund balance position to a positive $4 million (11% of spending) at the end of fiscal 2014. Surplus cash flow from operations and additional state settle-up payments and district taxing effort enabled full repayment of the liability to the capital projects fund nearly one year earlier than anticipated. The district made the final payment in October 2012 (fiscal 2013), and is spending down the repaid bond proceeds on approved capital projects.

CONCENTRATED TAX BASE; FLAT ENROLLMENT

The district’s TAV increased by nearly 6% for fiscal 2016 following two years of modest 2% growth. The increase reflects improving regional reassessment trends as well as some residential construction. The top 10 taxpayers make up a high 22.7% of fiscal 2016 TAV, though industry representation is somewhat diverse.

Enrollment has fluctuated in recent years with declines in two of the last five years caused in part by acute competition from a nearby charter school system and neighboring districts. Officials report that flattening enrollment is attributable to recent curriculum enhancements, including greater vocational offerings and a partnership with the local community college. Fitch considers management’s projections for stable enrollment to be reasonable given fewer losses to charter schools over the past two years. A declining enrollment trend would be of concern given the state’s attendance-based funding formulas.

Socioeconomic indicators for Hidalgo County are subpar, with low wealth levels, high poverty, and a persistently high unemployment rate. Despite modest employment gains, the November 2015 unemployment rate was 8%, up slightly from 7.7% one year prior. The employment growth trend is in line with the state and U.S.

AFFORDABLE LONG-TERM LIABILITIES

Overall debt levels are above average at 7.7% of market value and $6,574 per capita. Annual state debt service aid pays about 60% of debt service, resulting in an affordable fixed cost to the district equal to a low 4% of governmental fund expenditures in fiscal 2014. Amortization is above average with 65% of principal retiring in 10 years. The district’s facilities are relatively new, limiting capital needs to the projects that will be funded from the capital projects fund balance. Debt capacity under the state’s tax rate cap for new money debt issuance remains sufficient, due in part to bond refinancing in recent years that has allowed for reduction of the debt service tax rate.

Pension and other post-employment benefit (OPEB) liabilities are limited to the district’s participation in the Teacher Retirement System of Texas (TRS), a cost-sharing multiple employer plan for which the state funds the majority of employer pension contributions. Combined pension and OPEB spending consumed a modest 1.2% of fiscal 2014 governmental fund spending, and the district consistently funds its annual required contribution.

The state’s funding of school districts’ payments to TRS helps keep fixed costs low. However, like all Texas school districts, Hidalgo ISD is vulnerable to future funding changes by the state, as evidenced by a relatively modest 1.5% of salary contribution requirement effective fiscal 2015.

TEXAS SCHOOL DISTRICT LITIGATION

A 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 taxes are effectively a statewide property tax, due to a lack of local discretion and are therefore 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 less than 10% of existing tax-supported ratings. Fitch expects that final criteria will be approved and published by the end of the first 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 Fitch’s Tax-Supported Rating Criteria, this action was additionally informed by information from Lumesis and the Municipal Advisory Council of Texas.

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

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=998249

Endorsement Policy

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

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