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Fitch Affirms Palestine ISD, TX's ULT Bonds at 'AA-'; Outlook Stable
[August 24, 2016]

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


Fitch Ratings has affirmed the 'AA-' ratings on the following Palestine Independent School District, TX (the district) bonds:

--Issuer Default Rating (IDR);

--$107 million outstanding unlimited tax general obligation (ULT) bonds;

-- $6.2 million in outstanding maintenance tax notes, taxable series 2014.

The Rating Outlook is Stable.

SECURITY

The ULT bonds are payable from an unlimited property tax levied against all taxable property within the district and are further backed by the Texas Permanent School Fund bond guaranty program, rated 'AAA' by Fitch. (For more information on the Texas PSF bond guaranty program see 'Fitch Affirms Texas PSF Rating at 'AAA'; Outlook Stable', dated Aug. 5, 2015).

Maintenance tax notes are secured by a limited (operating) ad valorem tax pledge levied against all taxable property within the district, which cannot exceed $1.17 per $100 taxable assessed valuation (TAV).

KEY RATING DRIVERS

The 'AA-' IDR reflects the district's sound overall financial profile and limited economic base. The district's strong operating profile is supported by considerable expenditure flexibility and strong gap-closing capacity. Flat enrollment performance and ongoing population declines drive Fitch's expectation for slow revenue growth going forward. The district's moderate long-term liability burden is expected to remain manageable, given limited near-term capital plans.

Economic Resource Base

The district is located in Anderson County approximately 95 miles southeast of Dallas and 135 miles north of Houston. The city of Palestine serves as the district's population center and commercial hub. The enrollment base is small at 3,385 students in fiscal 2016. The area's economy is mainly rural and agricultural with below average socio-economic indicators. Assessed value (AV) has increased at a modest pace in recent years, suggesting slow but consistent economic growth.

Revenue Framework: 'bbb' factor assessment

A combination of local property taxes and state aid supports district operations. Slow revenue growth is expected to continue, given historical performance and modest enrollment growth forecasts, given ongoing population declines. The district's legal ability to raise revenues is limited.

Expenditure Framework: 'aa' factor assessment

The natural pace of spending growth is expected to remain in line with or modestly above that of revenues, given manageable near-term capital needs. The district's low carrying costs reflect state support for retiree benefits, bolstering spending flexibility.

Long-Term Liability Burden: 'aa' factor assessment

The combined burden of long-term debt and pension liabilities absorbs a moderate share of local personal income. Fitch expects debt levels to remain manageable, given the district's use of current resources to fund capital needs. Retiree benefit obligations do not represent a significant burden on the district.

Operating Performance: 'aaa' factor assessment

The 'aaa' operating performance assessment reflects the district's strong reserve funding levels relative to Fitch's expectations of revenue sensitivity, and a significant level of spending flexibility in the event of revenue declines.

RATING SENSITIVITIES

Maintenance of Financial Flexibility: The rating is sensitive to material changes in the district's currently strong expenditure flexibility and sound reserve levels, which Fitch expects it to maintain through a typical economic cycle. Draws on reserves beyond those currently expected could result in downward rating pressure.

CREDIT PROFILE

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 distrct).



Approximately 55% of district operating revenues come from state aid, with the remainder generated by local property tax revenues. Enrollment, which is a key component of state funding, has registered minimal over the last decade, driving slow revenue performance. Expectations for future revenue growth will hinge largely on enrollment trends, as the district's tax rate for operations cannot be increased without voter approval.

District revenues have grown at a compounded annual growth rate of 2.5% over the last decade, performing modestly above national CPI and below GDP growth. Fitch expects the natural pace of district revenue growth in future years to mirror or lag behind historical performance, given the expectations for slow enrollment growth and ongoing population declines in recent years. Fitch's expectations for strong state revenue growth somewhat offsets concerns related to potential enrollment declines, as state aid is tied to overall state revenue performance.


The district's independent legal ability to raise revenues is limited, as the current maintenance and operations (M&O) tax rate of $1.17 per $100 TAV is at the statutory cap. The district levies a separate, unlimited debt service tax rate of $0.40 per $100 TAV, near the statutory cap of $0.50 per $100 TAV that cannot be exceeded for new debt issuances.

Expenditure Framework

The district spends most of its operating budget on instruction, while also funding some annual capital outlay from general fund resources for maintenance and repairs on facilities.

Fitch expects the natural pace of spending growth to remain commensurate with revenues absent policy action. The district does not face any pressure related to enrollment, compensation, or capital spending, given the district's current enrollment profile, limited capital needs, and favorable labor environment.

The district's significant expenditure flexibility reflects substantial control over workforce costs, and very low carrying costs for debt service, pension and other post-employment benefits (OPEB) of 12.7% of fiscal 2015 governmental spending. Carrying costs benefit from state support for both debt service and the vast majority of school district pension and OPEB costs.

Long-Term Liability Burden

The district's long-term liability burden is very moderate at 10.4% of total personal income, and is made up almost entirely by the district's slow-amortizing outstanding debt load. The district's limited capital needs indicate that debt levels will likely remain low for the foreseeable future.

The district participates in the Texas Teachers Retirement System (TRS), a cost-sharing multiple employer pension system. Under GASB 67 and 68, TRS' assets covered 83.3% of liabilities as of fiscal 2015, a ratio that falls to 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 which state statute requires districts to assume. Like all Texas school districts, the district 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 year 2015. The proportionate share of the system's net pension liability paid by the district is minimal.

Operating Performance

The district has maintained a financial cushion at robust levels despite recessionary pressures and state funding cuts, garnering an 'aaa' assessment. Fitch believes the district would use its considerable expenditure flexibility to maintain a satisfactory level of financial flexibility in a moderate economic decline scenario.

The district has demonstrated a strong commitment to supporting financial flexibility. Budgeting is conservative and management has been proactive in using excess revenues to limit debt issuance and boost reserves. The district used general fund resources to fund capital projects in fiscal 2015, reducing fund balance to $9 million, or a healthy 30.5% of spending. The district projects breakeven results in fiscal 2016 with similar results budgeted for fiscal 2017.

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

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1010762

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1010762

Endorsement Policy

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

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON (News - Alert) THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.


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