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

--$170.8 million ULT school building bonds, series 2015-A.

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 Sept. 4, 2014.) Fitch also assigns an 'AA' underlying rating to the series 2015-A bonds.

The 2015 bonds are scheduled to sell via negotiated sale Aug. 4. Proceeds will be used to construct and equip school facilities and to pay issuance costs.

Fitch also affirms the district's approximately $736 million in outstanding ULT bonds at 'AA'.

The Rating Outlook is Stable.

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

KEY RATING DRIVERS

ROBUST FINANCIAL CUSHION: The district maintains ample reserves and liquidity despite some recent use of fund balance for non-recurring outlays. Strong financial performance has been aided by conservative budgeting practices and annual enrollment growth.

PART OF STRONG REGIONAL ECONOMY: The district's solid and diverse tax base benefits from its proximity to the Dallas-Fort Worth (DFW) metropolitan area, which continues to outpace the nation in total employment, population, and income growth. District residents enjoy access to employment opportunities in the DFW metro area as well as local employment opportunities anchored in the education, healthcare, and manufacturing sectors.

EXPANDING TAX BASE: Taxable assessed valuation (TAV) growth continues to strengthen after a modest, one-year contraction during the recession. Fitch believes further expansion over the near-term is reasonable given the ongoing pace of commercial and residential development underway and ample land available in the district.

ELEVATED LEVERAGE; MINIMAL FLEXIBILITY: The district is highly leveraged as a result of the rapid enrollment growth that occurred over the past decade. Key debt ratios are high, amortization is slow, and a high debt service tax rate that is at the statutory $0.50 per $100 TAV test for new debt issuance limits capital flexibility. The district is largely reliant on realizing solid TAV growth in excess of enrollment to provide additional debt capacity under the statutory test.

RATING SENSITIVITIES

STRONG FINANCIAL POSITION: Maintenance of structurally balanced operations and solid reserves will be key to future credit evaluations given the district's high debt levels and growth pressures.

GROWTH IN KEY DEBT METRICS: The overall debt burden is very high. Continued enrollment growth pressures will produce capital needs in the future, but Fitch expects key debt ratios to remain stable or improve slightly given the lack of near-term borrowing plans. Any further weakening of these debt metrics would not be consistent with the current rating category.

CREDIT PROFILE

DIVERSE & GROWING LOCAL ECONOMY ENHANCED BY DFW METRO PROXIMITY

Denton ISD is located approximately 35 miles north of Dallas and Fort Worth in Denton County, at the convergence of Interstate Highways 35 East and 35 West, and encompasses nearly 179,000 residents. Educational attainment and income/wealth metrics are generally above average. Proximity to the DFW metro area and the access provided by newly expanded toll roads and major highways as well as air and rail transportation have attracted a variety of industries and businesses to the area. An expanding service sector and manufacturing development also continue to diversify the district's mostly residential tax base.

Education and health services top the list of major area employers, which provided a measure of stability during the recession. The University of North Texas and Texas Woman's University are located in the city of Denton. Area employment indicators are strong, evidenced by continuing employment and labor force gains in the city and county. The Denton County unemployment rate improved to 3.6% from 4.8% for the 12-month period ending March 2015 despite a roughly 1% gain in labor force and has continued to trend below area, state, and national rates.

TAX-BASE GAINS STRENGTHEN

TAV grew at an average annual growth rate of roughly 4.5% from 2008-2015, reflective of continued expansion since the recession, and a strong 12% in fiscal 2015. Certified values indicate TAV expanded further in fiscal 2016 by a solid 8.2%. Fitch believes prospects for continuing TAV gains are positive over the near term due to development occurring within the district, the expanding housing market, and growing regional economy. Build-out of the district is presently estimated at roughly 50%.

Population and enrollment gains, which were significant over the past decade, are also continuing. Enrollment totals approximately 27,100 students in fiscal 2015, which reflects a more moderate 3% year-over-year gain after a period of growth at 4%-5% or about 1,000 students annually over fiscals 2011-2013. Actual student enrollment has remained on track with projections to date and the district's demographer projects a steady pace of 3% annual student growth to continue over the near-term.

SOLID FINANCIAL PERFORMANCE, RESERVES, & LIQUIDITY

Financial performance has remained strong despite the continuing capital and operating pressures associated with rapid enrollment growth. Unreserved/unrestricted general fund reserves have been no less than 27% over the last six fiscal years (fiscals 2009-2014). Historically conservative budgeting and spending practices have typically enabled actual operating performance in excess of expectations. The district posted positive results in four of the last six fiscal years, adding $26 million (roughly 13% of fiscal 2014 spending) to total general fund balance from fiscal 2009 to fiscal 2014. These results were notable given changes in the funding formula and sizeable state budget cuts that occurred over the last biennium (fiscals 2012-2013). In addition, management favorably funds most of its non-facility capital needs (buses, technology, etc.) with pay-as-you-go capital spending from operating reserves maintained well above the district's formal reserve policy floor (no less than two months or roughly 17% of general fund spending).

Audited fiscal 2014 results improved upon mid-year budget assumptions with roughly break-even operations and a modest $3 million (1.5% of spending) net addition to general fund balance, bolstered by proceeds from a one-time insurance settlement and the district's typical operating conservatism. Unrestricted general fund reserves totaled $76.1 million or 37% of spending at fiscal 2014 year-end.

Budgeted operations in fiscal 2015 again included a modest drawdown on general fund reserves ($4.7 million) in part for pay-go funding of some of the district's capital needs (technology, buses) and start-up costs for the opening of a new elementary school. Management reports there has been modest growth in enrollment-related revenues and expenditures due to somewhat higher than budgeted actual enrollment. The district expects to report break-even operations for fiscal 2015, although slower actual pay-go capital spending during the year should result in a modest net surplus at year-end according to management.

The adopted $223 million fiscal 2016 operating budget incorporates a modest gap ($2.1 million or 1% of spending), which Fitch anticipates will again be closed given generally conservative budget assumptions and prior fiscal years' performance. Spending is up 5% from the prior year due in large part to additional staffing needs and pay increases to maintain competitive teacher salaries.

HIGH DEBT RATIOS STEM FROM ENROLLMENT-DRIVEN CAPITAL NEEDS

The district's debt profile is Fitch's key credit concern. Overall debt ratios are high while the pace of principal amortization is slow at 31% in 10 years, reflecting the district's fast-growth environment and the related desire to meet facility demands while limiting the effect on existing taxpayers.

Overall debt levels comprise a very high 12% of market value and $10,060 per capita. Debt service also consumes a high 18% of the fiscal 2014 operating and debt service spending. Nonetheless, Fitch views the district's historically strong voter support for its bond programs as mitigating some concern over these debt levels.

The district's debt portfolio contains about 30% of mostly hedged variable-rate debt, which Fitch views as high. Although the high debt service burden somewhat elevates this concern, the district maintains a policy to keep variable-rate debt issuance at a maximum of 30%. Moreover, approximately 34% of the outstanding variable-rate debt is currently synthetically fixed and all other outstanding variable-rate debt presently carries a fixed interest rate in its initial, three-year rate period.

DEBT SERVICE TAX RATE LIMITS CAPITAL FLEXIBILITY

Of additional concern to Fitch is the district's limited flexibility in meeting future capital needs due to a debt service tax rate ($0.50 per $100 TAV in fiscal 2015) that is at the statutory limit for new debt issuance. The tax rate cap for new money debt somewhat mitigates the risk of sharp increases in debt levels over the near term, but it can also serve to constrain fast-growth districts' ability to meet capital needs, absent sufficient tax base growth.

This new money issuance exhausts all outstanding GO bond authorization. It is projected to provide sufficient facility capacity for all grade levels over the near term, although student growth pressures are expected to persist. This issuance maintains the district's existing 30-year amortization schedule, which is projected to be supported by the current $0.50 debt service tax rate under fairly conservative TAV growth assumptions. Fitch expects a future GO bond election in the near to intermediate term given the district's ongoing enrollment gains, although district management has no firm plans presently.

OTHER LONG-TERM LIABILITIES MANAGEABLE

Fitch's concern about the elevated level of the district's debt is lessened by the moderate overall long-term liability burden when considering pension and other post-employment benefits (OPEB). 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 2014), with the exception of district contributions for probationary employees and for benefits on employees' salaries that exceed the TRS statutory minimum. Other post-employment benefits (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 a high and growing debt burden.

Carrying costs for the district (debt service, pension, OPEB costs, net of state support) totaled a manageable 16.4% of governmental fund spending in fiscal 2014 due largely to slow principal amortization and they are expected to remain manageable despite a moderate rise in the debt service schedule in fiscal 2016 that remains fairly level through MADS in fiscal 2033. Pension contributions for all districts in the state rose to 1.5% in fiscal 2015 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. Any changes that include additional funding for schools and more local discretion over tax rates would be positive credit factors.