OREANDA-NEWS. Fitch Ratings affirms Beaumont Independent School District, Texas' (the district) outstanding unlimited tax (ULT) bonds as follows:

--\$389 million outstanding ULT bonds at 'BBB+'.

The Rating Outlook remains Negative.

SECURITY
The bonds are payable from an unlimited property tax levied annually (distinct from the district's operating levy) against all taxable property within the district. Additional security is provided by the Texas Permanent School Fund (PSF) guaranty, whose bond guaranty program is rated 'AAA' by Fitch.

KEY RATING DRIVERS

BOARD OF MANAGERS IN PLACE: The Texas Education Agency (TEA) appointed a local board of managers and interim superintendent in July 2014 to oversee general operations and replace the elected school board trustees and existing superintendent. The state's intervention was largely anticipated by Fitch as severe financial management issues had been highlighted as a result of a FBI embezzlement investigation and the district's accreditation status had worsened.

EVOLVING FINANCIAL PROFILE: Fitch believes the current 'BBB+' rating and Negative Outlook adequately reflect the district's evolving financial picture. Previously solid and stable reserves that were historically a credit strength have eroded as new management accounted for prior fiscal years' budgetary overspending, fraud, and the lack of adherence to financial controls and reporting requirements. However, the much-diminished fiscal 2014 financial position is balanced against a modest operating surplus projected at fiscal 2015 year-end. Internal liquidity has been sufficient to date without the need for external borrowing and forward-looking cash flow projections provided by management appear adequate and reasonable.

CONCENTRATED TAX BASE: Underpinning the district's credit quality is a tax base heavily concentrated in the petrochemical industry; this lack of diversity constitutes a measure of risk to the district. The leading taxpayer, Exxon Mobil Corporation, provides a high 19% of taxable assessed value (TAV). TAV has grown modestly in recent fiscal years.

OVERALL DEBT HIGH; MODERATE CARRYING COSTS: Overall debt levels are above-average and principal amortization of the district's direct debt is slow. Carrying costs are moderate and are expected to remain so given the lack of new debt plans, a level debt service schedule, and the bulk of its employer pension costs paid for by the state.

RATING SENSITIVITIES

MATERIAL CHANGE TO FINANCES: Rating stability and/or positive rating action is contingent upon the district's ability to restore reserves, maintain structural operating balance, and steadily resolve key audit findings. The fiscal 2015 budget represents a credible first step by the district to achieve these goals. The rating is sensitive to any unanticipated findings from internal or external audits/investigations that might have a material impact on the district's financial resources.

CREDIT PROFILE
The district is part of the larger Beaumont-Port Arthur metropolitan statistical area (MSA), a four-county region in southeast Texas whose economy is primarily supported by petroleum-related industries. District enrollment has remained fairly stable at about 19,500 students. Wealth and income indices are below state and national averages.

STATE TAKEOVER
The TEA Commissioner announced his appointment in July 2014 of an interim Superintendent and a board of managers to assume responsibility for operations and governance of the district, replacing the existing superintendent and elected board of trustees. This decision was due in part to the severe financial management issues that had been highlighted as a result of an earlier FBI embezzlement investigation. The board was charged by the Commissioner to not only oversee district operations, but to correct identified deficiencies and implement structural and procedural improvement strategies for long-term, positive change.

A majority of the members on the appointed board are from the Beaumont community and this board is expected to remain in its supervisory role through May 2017, at which time an election for a new board of trustees is anticipated. This new management team subsequently hired an interim finance director whose experience appears to fit well with the district's needs, particularly the turn-around of other troubled districts' finances as a TEA conservator/ monitor and prior tenure as Beaumont ISD's finance director. The board of managers also recently made headway on establishing future leadership for the district with announcement of the lone finalist for Superintendent; the candidate is a veteran educator with broad, national experience, inclusive of three superintendent positions.

INTERNAL LIQUIDITY SUFFICIENT
Fitch's cash flow concerns were initially triggered upon learning of the embezzlement that totaled \$4 million (2.5% of spending) by the former finance director and comptroller early in fiscal 2014. Other fiscal mismanagement issues that became highlighted as a result led Fitch to request cash flow documents from the district's prior financial consultants that did not materialize, although cash flow was generally described as narrowly adequate through fiscal 2014. The recently released fiscal 2014 audit confirms this description with \$11.6 million in cash/investments reported for all governmental funds or about 5% of total governmental spending.

Fitch believes the district maintains sufficient cash flow over the near term. This assessment is based on cash flow statements provided by the current finance director that demonstrate adequate monthly cash flow through December 2015 with a residual balance of no less than \$34 million in available funds across all funds. Underpinning these projections is the district's planned receipt of state aid in line with TEA's established payment schedule, which allows for proportionate distribution of the year's total state aid payment in months when property tax revenue is relatively minimal.

MODEST SURPLUS PROJECTED BY FISCAL 2015 YEAR-END
Development of the next fiscal year's (fiscal 2015) budget was an immediate task when the new management team came onboard. Expenditure cuts were viewed as crucial to restore structurally balanced operations amidst a historically stable enrollment environment and rebuild the reserve cushion. Management leaned heavily on non-teaching staff reductions; roughly 300 full-time positions were eliminated for about \$12 million in budgetary savings. Conservative revenue estimates incorporated projections of a roughly 4%-5% decline in enrollment. Nonetheless, the adopted \$145 million operating budget (largely derived from property tax revenue) anticipated a healthy \$8.6 million surplus (6.3% of spending) by year-end.

Management currently expects to boost reserves by no less than the aforementioned budget surplus at fiscal 2015 year-end. Enrollment-related revenues are up slightly year-to-date with a lower 2% student decline while spending remains generally in line budget. Other mid-year cuts to travel and staffing of the district's internal police department totaled about \$2 million and should provide some cushion against unanticipated change in revenues or expenditures. Fitch acknowledges the year's positive traction, but reserves remain minimal despite the solid gain planned.

The new management team appears to have rapidly quantified and resolved many of the prior fiscal mismanagement issues to date, including inaccurate enrollment reporting in prior fiscal years that resulted in a \$500,000 reduction in state aid for fiscal 2015. No federal or state audits/investigations are underway or pending according to management that might materially pressure the district's presently weak financial position. This is despite the numerous material weaknesses and deficiency findings noted in the fiscal 2014 audit for various federal and state award programs.

FY 2014 AUDIT NOW COMPLETE; FY 2013 AUDIT ANTICIPATED SHORTLY
Completion of both the fiscal 2013 and 2014 audits was delayed in large part to the significant audit and investigation work required. The recently released fiscal 2014 audit was prepared by a newly engaged audit firm and management reports the lagging fiscal 2013 audit will also be completed shortly as it was developed in conjunction with the 2014 audit. Unaudited fiscal 2013 year-end projections appear to be fairly comparable with Fitch's prior expectations; unrestricted reserves total about \$8 million or about 5% of spending at fiscal 2013 year-end. The one year use of about \$18 million in reserves was reportedly due to a combination of unbudgeted pay-go capital spending, embezzled funds, and higher than budgeted spending on personnel throughout the year.

Fiscal 2014 results bear out Fitch's previously elevated uncertainty surrounding the year's fiscal performance. The \$3 million structural operating imbalance in the initial \$157.8 million budget subsequently widened to a total of \$7.2 million (about 5% of spending) by mid-year. The larger deficit resulted from a miscalculation of property taxes from one of the district's larger taxpayers, reflecting previous changes to the state school funding formula. Management was able to close roughly \$700,000 of the year's gap with curtailment of spending, however the district's financial position still deteriorated. The district recorded a negative \$536,000 or -1% of spending unrestricted reserves; the total general fund balance was a weak \$2 million or 1.3% of spending. Fiscal 2014 general fund numbers largely rely on a qualified audit opinion due to the limitations inherent in non-completion of the fiscal 2013 audit.

TAX BASE CONCENTRATED IN PETROCHEMICAL INDUSTRY
The district's tax base remains heavily concentration in the petrochemical industry, although this concern is mitigated to a degree by industry diversification in both production and end users as well as the key role oil refineries play in the national economy. TAV has grown at an average pace of 2.5% annually since fiscal 2008; TAV held stable at \$10 billion in fiscal 2015. Expansion by the district's largest taxpayer (an ExxonMobil refinery) has been the primary contributor to increased tax base concentration, which may grow further in the near term. The company reportedly has plans for an expansion that could make the facility the largest in the United States. Top 10 taxpayers contributed 30% of TAV in fiscal 2015, led by the refinery at 19%.

Fitch believes the area may realize some modest economic softening in the near to intermediate term given the interconnectedness of the energy sector and the resulting effects from subdued exploration activity due to sustained, low oil prices. However, the state's various petrochemical centers should benefit from lower energy prices, which may serve as a partial offset to any economic softening. (For more details, see 'Fitch: Oil Price Decline Likely to Have Targeted Effect on Local Texas Economies & Revenues', dated Jan. 13, 2015).

OVERALL DEBT BURDEN ABOVE-AVERAGE; CARRYING COSTS MODERATE
Overall debt levels are above-average at approximately 5.4% of TAV. Principal amortization of the district's direct debt is slow with roughly 34% retired in 10 years. Carrying costs for the district (debt service, pension, other post-employment benefit costs, net of state support) are moderate and totaled 13.3% of governmental fund spending in fiscal 2014 due primarily to the slow pace of principal amortization and the state paying the bulk of the district's employer pension costs.

The district exhausted its general obligation bond authority with completion of its \$388 million bond program, approved by 57% of voters in November 2007. A forensic audit that focuses on the 2007 bond program is currently underway and expected to be finalized in the next few months. All bond projects were completed according to management, but in some cases there may have been payment in prior fiscal years to original contractors that did not complete the work, which is expected to be actively pursued for restitution by the district through the courts.