Fitch Rates Dallas ISD, TX's Series 2015 Ltd Maintenance Tax Notes 'AA+'
--\$75 million multi-modal limited maintenance tax notes, series 2015.
The bonds are scheduled for negotiated sale the week of July 6. Proceeds will be used to repair, equip and replace existing school facilities and pay issuance costs.
The Rating Outlook is Stable.
SECURITY
The bonds are direct obligations of the district, payable by a limited property tax for operations (\$1.04 per \$100 taxable assessed valuation (TAV)) levied against all taxable property within the district.
KEY RATING DRIVERS
STRONG FINANCIAL POSITION MAINTAINED: The high 'AA+' rating reflects the district's strong financial position and ample flexibility characterized by very sound fund balance and liquidity levels. Management's conservative budgeting and tighter spending controls have contributed to consistent, sizeable operating surpluses over the past five fiscal years. Positive budget performance is again projected for fiscal 2015.
SOUND ECONOMIC PERFORMANCE: Dallas benefits from its status as a regional economic and cultural hub. Steady job and income growth, recent tax base and housing market growth, and labor market diversity underpin the city's strong economy.
BELOW-AVERAGE DEMOGRAPHICS: Wealth levels remain somewhat below average and the poverty rate is elevated, reflecting a sizable low-income populace concentrated in the city.
LONG-TERM LIABILITIES WILL GROW: Debt ratios are above average and will likely increase over the near to medium term given the size of outstanding capital needs, debt plans, and the slow rate of amortization. Mitigating factors include a low tax rate for debt service, budget capacity to support the additional debt, and modest retiree benefit costs.
NO RATING DIFFERENTIAL: Fitch does not distinguish between the unlimited and limited tax ratings due to the district's significant financial flexibility.
RATING SENSITIVITIES
STABILITY OF FISCAL TREND: Fitch views maintenance of fiscal balance and stability in the district's reserve cushion as key mitigants to debt levels that are poised to increase and the district's slightly below-average socio-economic profile.
CREDIT PROFILE
Dallas ISD serves a student population of roughly 160,400 making it the second-largest school district in the state and 14th largest in the nation. Enrollment growth is modest. The district serves the majority of the city of Dallas, as well as all or portions of 11 area cities and towns, with a total estimated population of approximately 1.3 million.
STEADY SURPLUSES BUILD STRONG FISCAL POSITION
General fund results in fiscal years 2010-2013 featured positive annual operating margins after transfers in the 3%-7% range (between \$32 million and \$80 million) and corresponding increases in fund balance. This steady improvement in the district's financial performance (which was notably achieved in the face of state funding cuts) was largely attributable to staffing-related expenditure reductions and conservative budgeting practices. Maintenance of vacant positions and tighter departmental spending controls allowed operations to outperform the balanced budgets.
Fiscal 2014 general fund results maintained this positive trend. The district benefitted from increased state per pupil funding levels in the current biennium (fiscals 2014-2015). The additional revenue provided the bulk of support for the year's 4% growth in spending that was largely directed to additional staffing and a 2% pay increase. A roughly \$62 million net surplus brought the unrestricted general fund balance up to approximately \$335 million or 25% of spending; this was net of \$25 million transferred out from the year's surplus operations towards future technology and deferred maintenance needs.
The district's liquidity position was also robust. General fund cash and investments totaled \$406.6 million or about 3 1/2 months of fiscal 2014 operating expenditures. Management continues to make progress in resolving prior years' material weaknesses and deficiencies in reporting, bolstering its internal control systems.
MODEST SURPLUS PROJECTED IN FISCAL 2015
The \$1.3 billion fiscal 2015 general operating budget was adopted as balanced with about 8% growth in spending. Additional staffing and the funding of various board priorities, inclusive of a 3%, across-the-board pay raise that provided some catch-up in maintaining competitive salaries, drove much of the year's increase. Management expects a modest 1%-2% net surplus (up to \$20 million) at year-end due primarily to salary savings. Fitch considers this projection reasonable based on the district's use of similar budgeting practices that produced large surpluses over the last five fiscal years. The proposed \$1.4 billion operating budget for fiscal 2016 is structurally balanced, assumes fairly flat enrollment, and provides average salary increases of 3% and 4% for staff and teachers, respectively, that total about \$30 million.
The district does not practice formal out-year budget forecasting, but generally expects spending to increase and margins to narrow as service levels are enhanced to address academic performance goals. Despite the lack of forecasting and a formal fund balance floor, Fitch believes the district will continue to preserve its presently strong financial position under the assumption management will continue its fiscal practices to date that have contributed to a much-improved financial track record despite various budgetary pressures.
END OF HOME-RULE SCHOOL DISTRICT CHARTER INITIATIVE
A successful petition initiative (signed by at least 5% of district's voters in May 2014) required the district to put before voters a proposed change to its operating structure, from that of an independent school district to a home-rule charter district. Traction on this measure recently ended, however, as the district's appointed charter commission decided with a majority vote in January 2015 not to proceed with writing a home-rule charter for eventual voter consideration.
Change to the district's operating structure in this manner is viewed by Fitch as a credit neutral. State law indicates adoption of a home-rule charter does not affect the district's boundaries, taxes or bonds authorized before the date of the charter. A home-rule district remains subject to federal and state laws and rules governing school districts.
DALLAS ECONOMY IN EXPANSION MODE
Dallas, together with its sister-city Fort Worth, is an economic and cultural hub for the southwestern U.S. Dallas is a center for technology, trade, finance and major medical centers; it also ranks as a top visitor and leisure destination in the state. The area is home to 18 Fortune 500 companies as of 2014. The city exhibited good resiliency during the national recession and shifted into economic expansion earlier than many other parts of the country. DFW has seen cumulative job growth of about 12% since the 2009 recessionary trough, led by gains in the professional/business services and health and education sectors.
District socioeconomic indicators are mixed with relatively low unemployment, sound tax base wealth per capita, but slightly below-average income levels and a high occurrence of poverty. As of March 2015, the city's unemployment rate was 4.1%, a decrease from 5.5% a year ago. Employment gains during this period were solid at just under 3%. The district's fiscal 2015 taxable assessed value increased 7% from last year to \$85.6 billion and preliminary fiscal 2016 estimates from the appraisal district indicate a stronger 8.5% gain. Fitch believes prospects for continued economic growth for the area remain favorable.
MANAGEABLE DEBT BURDEN, LARGE CAPITAL NEEDS
Fitch considers the district's direct and overlapping debt burden to be slightly above average relative to full market value at 5.2% but expects this to rise given future borrowing plans. The district's debt load has increased in the past several years due to borrowings associated with a \$1.35 billion bond program initiated in 2008. The district has exhausted this authorization and is wrapping up the associated building program. The pace of debt retirement slowed considerably as a result of recent offerings and remains well below average at roughly 36% of principal repaid in 10 years, inclusive of this issuance.
Future capital needs are large, estimated at about \$1.5 billion to fund slightly less than 10 years of capital projects. The district plans to use a measured portion of its general fund reserves (up to \$43 million) over the near-term for pay-as-you-go spending to meet some of its most immediate capital needs in conjunction with this issuance.
District officials may approach voters in November 2015 for a \$1.5 billion GO bond authorization or a tax ratification election based on a maximum \$0.13 increase to the operating tax rate that is estimated to have a similar tax rate impact or a combination of the two options. The full \$0.13 tax ratification option (if selected) is projected to provide some added financial flexibility for funding programs, pay-as-you-go cash funding for capital projects as well as some planned short-term debt.
However, the district does have budget capacity for additional debt. The fixed debt service burden on the budget is affordable at 11.5% of total governmental expenditures in fiscal 2014, although it totals a sizeable 21% when maximum annual debt service (MADS) in fiscal 2033 is considered. The current 24-cent debt service tax rate provides ample headroom under the state's statutory 50-cent tax rate limitation for new debt issuance.
The series 2015 maintenance tax notes will have a variable interest rate in order to minimize the impact to its debt service tax rate, which Fitch believes does add incremental risk to the district's credit profile. Management expects to maintain no more than 25% of its total outstanding and authorized debt as variable rate in line with the district's debt management policies, which Fitch believes is reasonable.
The notes are structured with an initial fixed-rate term, a soft put back to bondholders in lieu of liquidity support, and the option to periodically reset the rate to a long-term fixed basis. The bonds are subject to optional and mandatory redemption by the district, and following the initial rate period, the district can change the interest rate mode and rate period. Bondholders will be required to tender their bonds under certain conditions on specific dates.
The risk to the district is in the case of a failed remarketing, whereby the district would pay an elevated but manageable interest rate. Fitch considers the risk of a failed remarketing minimal based on the district's rating which indicates strong market access, as well as the district's strong financial position.
AFFORDABLE RETIREE COSTS
Fitch's concern about the district's overall long-term liabilities is lessened by its low retiree cost burden. Pension and healthcare benefits are provided through the Teacher Retirement System of Texas (TRS), a cost-sharing multiple-employer plan for which the state provides the bulk of the employer's annual pension contribution. Total pension and OPEB contributions made by the district in fiscal 2014 totaled less than 2% of governmental fund expenditures.
The TRS funded position was 80.8% as of Aug. 31, 2013, although Fitch estimates the funded position to be lower at 72.8% when a more conservative 7% return assumption is used. 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 contribution. Increases in pension funding requirements beyond the 1.5% increase for all districts in fiscal 2015, while not presently anticipated, could create additional budget pressure.
The state's payment of district pension costs is an important credit strength, as it keeps overall carrying costs manageable in the face of a large and growing debt burden. Carrying costs for the district (debt service, pension, OPEB costs, net of state support) totaled a moderate 13% of governmental fund spending in fiscal 2014 due in part to slow principal amortization, and they are expected to remain manageable.
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. Any changes that include additional funding for schools and more local discretion over tax rates would be positive credit factors.
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