OREANDA-NEWS. Fitch Ratings assigns an 'AAA' rating to the following Port Arthur Independent School District, Texas' (the district) unlimited tax (ULT) bonds:

--\$85.5 million unlimited tax (ULT) school building bonds, series 2015A.

The 'AAA' 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 more information on the Texas Permanent School Fund see Fitch Affirms Texas PSF Rating at 'AAA'; Outlook Stable, dated Sep. 4, 2014.)

Fitch also assigns an 'AA-' underlying rating to the series 2015A bonds and to the \$34.1 million series 2015B ULT refunding bonds and affirms the 'AA-' underlying rating on the district's \$247.5 million (pre-refunding) in outstanding parity bonds.

The bonds are scheduled to sell the week of Feb. 23rd via negotiated sale. Proceeds will be used to construct and renovate various school facilities, refund certain outstanding maturities for savings, and to pay related costs of issuance.

The Rating Outlook is Stable.

SECURITY

The series 2015A and 2015B bonds are payable from an unlimited property tax levied against all taxable property within the district. The series 2015A ULT bonds are also insured as to principal and interest repayment from a guaranty provided by the PSF.

KEY RATING DRIVERS

STRONG RESERVES MAINTAINED: A pattern of net operating surpluses over the last three fiscal years has continued to build up already strong reserve levels. Fitch believes the district's strong reserves are a key credit strength given its highly concentrated tax base and relatively flat enrollment growth.

HIGHLY CONCENTRATED TAX BASE: The district's tax base is highly concentrated in terms of industry composition (oil, gas and chemicals) and among individual taxpayers, resulting in a tax base inherently susceptible to ongoing assessment appeal activity which can have a magnified impact on revenue loss. The district's high reserves provide an adequate cushion to partially offset these concerns.

WEAK SOCIO-ECONOMIC METRICS: The local economy is limited, evidenced by an unemployment rate significantly higher than state and national averages. Wealth indices remain below average.

TAV DECLINE: Reduced valuation from successfully protested industrial properties resulted in a moderate TAV decline after a string of sizeable gains from significant investments made by various top taxpayers. Nonetheless, Fitch believes that absent new appeals, some modest TAV growth is likely over the near-term given further industry investment planned or underway.

MIXED DEBT AND LIABILITIES PROFILE: Fitch expects the district's overall debt burden to remain above-average and principal amortization to be slow given plans to utilize new bond authority while minimally increasing the debt service tax rate. This is balanced against manageable carrying costs, which are due largely to the state funding the bulk of retiree pension and healthcare costs on behalf of districts.

RATING SENSITIVITIES

EROSION OF FINANCIAL FLEXIBILITY: Fitch views a healthy level of reserves as the primary mitigating factor to the credit risks associated with the district's highly concentrated tax base, settled and potential future tax payer appeals, lack of revenue flexibility to address such settlements, and high debt levels. Notable erosion in reserves could result in negative rating action, but the risks make positive rating action unlikely.
CREDIT PROFILE

The district is part of the Beaumont-Port Arthur metropolitan statistical area (MSA), a three-county region in southeast Texas whose economy is primarily supported by petroleum-related industries. The district's average daily attendance (ADA) was 8,156 students in 2014, reflective of just under a 1% decline over the past six fiscal years. Management projects ADA will remain relatively flat over the next several years.

SIZEABLE RESERVES MAINTAINED DESPITE TAX REPAYMENTS

The district's financial position remains strong despite the recent effect of two separate property tax disputes between Valero Energy (Valero; formerly Premcor)--the district's second largest taxpayer--and the county appraisal district. The district was required to rebate a total of \$32 million for the two appeals; this amount was offset by receipt of \$13.1 million from the state due to the lowered property tax valuation.
Settlement of the first lawsuit in 2011 resulted in an adverse ruling for the district and subsequent gross tax rebate of \$18.5 million, payable over six years through fiscal 2017. This amount was attributed to prior property tax revenue the district received over tax years 2006 - 2010 (fiscals 2007 - 2011). The remaining \$8.5 million liability will be paid over the next three fiscal years (\$3 million each in fiscal 2015 and 2016, and \$2.5 million due in fiscal 2017).

The second lawsuit recently settled in 2014 was for tax years 2012 and 2013 (fiscals 2013 - 2014) and resulted in another required tax rebate by the district to Valero of \$13.5 million. The debt service fund balance provided the bulk of the \$6.3 million repayment that was initially required in fiscal 2014 for this second settlement. The final repayment totals \$5.8 million and will be paid in May 2015 (fiscal 2015) solely from the general fund with no additional state reimbursement anticipated.
Fiscal 2014 operating results were bolstered by a \$5.6 million state reimbursement owed under the revised tax base valuation. The district generated a net surplus after transfers of \$6.2 million (8% of spending) that bolstered unrestricted reserves to \$39 million or a high 51% of spending at fiscal 2014 year-end. Liquidity in the general fund remained strong as well at \$30.8 million or over four months of fiscal 2014 spending.

The fiscal 2015 \$74.4 million operating budget was adopted as structurally balanced and management indicates operations are generally running in line with budget while actual enrollment is up slightly. Year-end general fund projections currently estimate a roughly \$9 million draw on reserves given the required property tax repayments to \$30 million or a still strong 40% of spending.

No further tax appeals are underway by Valero to date or by any other top taxpayers according to district officials. However, the uncertain effect of potential future appraisal litigation on the district's budget is a key credit concern. Although Fitch believes that the district's general fund reserve levels provide an adequate cushion to absorb the tax rebate liability currently due, recurring revenue losses arising from a negative outcome could erode financial flexibility and result in negative rating action.

HEAVY TAX BASE CONCENTRATION IN THE OIL/GAS & CHEMICAL SECTORS

Taxpayer concentration is a credit concern; the top 10 payers comprise a high 29% of fiscal 2015 TAV and are nearly all part of the oil, gas, and chemical sectors. Motiva Enterprises LLC (Motiva) is the leading taxpayer at 8.8% of fiscal 2013 TAV, followed by Valero at 6% of TAV. Fitch believes the essentiality of oil and gas refining in the U.S. make the closure of these plants unlikely, but expects the exposure to TAV volatility to continue.

TAV uncharacteristically declined by a moderate 10% in fiscal 2015 largely due to the reduced values stemming from the aforementioned, successful tax protests. This followed a trend of strong annual tax base growth over much of fiscals 2009 - 2014 driven by capital improvements and expansions of major refineries. Due to the expansive industrial base, the district's market value per capita is a high \$147,000, making this a property-rich district under the state's funding framework, although the district is not required to make equalization payments to the state as a result of its property-rich classification at this time. Nonetheless, local property taxes comprise over 50% of total general fund revenue, making the district more susceptible to revenue loss as a result of declining TAV not fully offset by state aid. Wealth and income indices are below state and national averages.

MIXED DEBT AND LIABILITIES PROFILE

The district's overall debt burden is above average at 5% of market value and \$7,385 per capita. Amortization of direct principal is slow with around 30% retired within 10 years. The new money portion of this issuance includes the first part of a \$195 million bond authorization approved by voters at a strong 68% margin in November 2014. The bond package will fund the replacement/expansion of three elementary schools as well as a new ninth grade center that should meet the district's facility needs over the next ten years. Full use of the remaining authorization is presently projected over the next five to seven years, allowing for some TAV growth and maintenance of the debt service tax rate in line with the small increase promised voters that would bring the rate to no more than \$0.32 per \$100 TAV.

AFFORDABLE RETIREE COSTS

Fitch's concern about the district's overall long-term liabilities is lessened by its low retiree cost burden. Retiree pension and healthcare benefits are provided through the Teacher Retirement System of Texas (TRS), a cost-sharing multiple employer plan. The district's annual contribution to TRS is determined by state law as is the contribution for the state-run post-employment benefit healthcare plan; the district consistently funds its annual required contributions. District employees contribute to TRS for pensions at 6.4% of annual payroll, and the state pays the local district's contributions (6.4% of payroll in fiscal 2013), with the exception of district contributions for probationary employees and for benefits on employees' salaries that exceed the TRS statutory minimum. Other post-employment benefit (OPEB) contributions paid by the district are nominal as the state and employees also pay the bulk of these costs. Total pension and OPEB contributions made by the district in fiscal 2014 totaled less than 1% of governmental fund expenditures.

TRS reported a funded ratio of 80.8% as of Aug. 31, 2013, though Fitch estimates the funded position to be lower at 72.8% when a more conservative 7% return assumption is used. The state's payment of district pension costs is an important credit strength as it keeps overall carrying costs manageable in the face of an elevated debt burden. Carrying costs for the district (debt service, pension, OPEB costs, net of state support) are generally manageable and totaled a moderately high 22.6% of governmental fund spending in fiscal 2014 due largely to a spike in the district's annual debt service. Starting in fiscal 2015, pension contributions for all districts in the state rose to 1.5% on the statutory minimum portion of payroll, from zero, increasing carrying costs further. Increases in district funding requirements beyond fiscal 2015, while not presently anticipated, could create additional budget pressure.

TEXAS SCHOOL FUNDING LITIGATION

A Texas 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, found the system inefficient, inequitable, and underfunded. The judge also ruled that local school property taxes are effectively a statewide property tax due to lack of local discretion and therefore are unconstitutional.

Following a similar ruling in February 2013, the judge granted a motion to reopen the lawsuit four months later after state legislative action that partially restored state funding levels and made other program changes. 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 will be directed to make changes to the system to restore its constitutionality. Fitch would view positively any changes that include additional funding for schools and more local discretion over tax rates.