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

--$49 million ULT refunding bonds, series 2016.

The 'AAA' long-term rating reflects the guarantee of the Texas Permanent School Fund (PSF; bond guarantee program is rated 'AAA' by Fitch).

The series 2016 ULT bonds are scheduled for a negotiated sale March 9. Proceeds will be used to refund certain outstanding obligations for debt service savings and to pay issuance costs.

Fitch also assigns an underlying 'AA-' rating to the series 2016 bonds and affirms its 'AA-' underlying rating on the district's $58.1 million (pre-refunding) outstanding ULT debt as well as to the $6.2 million in outstanding maintenance tax notes, taxable series 2014.

The Rating Outlook is Stable.

SECURITY
The bonds are payable from the district's levy of an unlimited ad valorem tax on all taxable property within the district and also carry the Texas PSF bond guaranty (for more information on the Texas PSF, 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

STRONG FISCAL POSITION: Consistent surplus operations, robust reserves, and healthy levels of liquidity characterize the profile.

MANAGEABLE LONG-TERM LIABILITIES: Moderate debt levels should decline modestly over time given the district's limited capital and debt needs. Principal amortization is very slow. Low carrying costs are largely attributable to the significant role played by the state in funding pensions.

NARROW ECONOMIC BASE: The area's economy is mainly rural and agricultural with below average socio-economic indicators. The government and retail sectors provide a significant share of local employment.

FLAT TAX BASE; MODERATE CONCENTRATION: The district's stable tax base manifests modest and consistent growth. Top 10 taxpayer concentration is moderate.

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 FINANCIAL PROFILE: Fitch views maintenance of fiscal balance and stability in the district's reserve cushion as key mitigants to the generally slim TAV and enrollment gains.

CREDIT PROFILE
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.

NARROW LOCAL ECONOMY
In addition to agricultural interests and energy production, primary employment sectors consist of government (including a number of correctional facilities), retail trade, manufacturing, and healthcare. The current economically weakened energy environment has modestly slowed the county's economic momentum year-over-year despite the stability of its other employment sectors. Unemployment levels are up slightly to 4.4% in December 2015 from 3.8% a year ago. The county's unemployment rate remained generally in line with the state (4.2%) while rising slightly above the state (4.8%). Income levels as well as educational attainment metrics are low with median household income for the Palestine metro area at approximately 75% of the state and national averages.

TAX BASE REFLECTS MODERATE CONCENTRATION
Tax base gains have been steady but modest at a 1% annual average from fiscal years 2011-2016. Management anticipates relatively comparable TAV performance over the near term. Market value totaled roughly $1.5 billion in fiscal 2016 or a moderate $69,000 on a per capita basis. Some concentration is apparent among the stable list of top 10 taxpayers; they account for 14% of fiscal 2016 taxable assessed value, led by Wal-Mart with approximately 3.4% of the tax base.

Fitch's concerns about any future TAV declines, from a fiscal standpoint, are largely mitigated by the state's funding formula, which generally ensures level per-pupil funding formulas by backfilling lost local revenues with additional state aid for operations.

ROBUST RESERVE CUSHION
The district maintains a strong and stable financial position with typically positive operating results. District operations have annually generated surpluses in seven of the last eight fiscal years (fiscals 2009-2015) with modest drawdowns periodically for capital spending. Good budgetary practices by management and a voter-approved increase to the district's operations and maintenance (O&M) tax rate to the state maximum ($1.17 per $100 TAV) in place since fiscal 2008 underpin these results. In addition, the district benefitted from increased state per pupil funding levels in the last biennium (fiscals 2014 - 2015).

Expanded enrollment in the district's career and technology programs boosted student-related revenues in fiscal 2015. Overall, year-over-year enrollment grew by a solid 3%, which was in contrast to generally flat performance since fiscal 2011. Fiscal 2015 results included a drawdown on reserves of almost $1 million due largely to audit adjustments as well as some unanticipated capital spending at the high school. The district preserved $9 million in unrestricted general fund balance at fiscal 2015 year-end, equal to a strong 30.5% of spending and well above its three-month fund balance policy. Liquidity was also ample at four months of recurring operating expenses.

The fiscal 2016 $28.8 million operating budget was structurally balanced without the use of reserves and based on a projection of flat average daily attendance (ADA). District management indicates year-to-date ADA is slightly ahead of budget. Operations remain in line with budget, although modest capital spending plans are likely to slim year-end results to break-even.

MANAGEABLE LONG-TERM LIABILITIES
The district's overall debt burden is moderate at approximately $3,700 per capita and 5.1% of fiscal 2016 market value. Inclusive of this issuance, amortization remains slow at 30% of principal retired in 10 years. Annual debt service for the district's ULT bonds is projected to descend modestly in fiscal 2017 while remaining generally level thereafter. Fitch does not anticipate that the $4 million debt service costs, equal to 11% of fiscal 2015 governmental spending will pressure the credit.

Proceeds from the 2009 GO bond authorization improved all of the district's six campuses. Critical facility issues that recently arose from allegedly faulty construction paid for by bond funding were addressed in fiscal 2015 with pay-go general fund spending. Management indicates no further spending is presently required and all affected school facilities are operational. The district expects to pursue litigation for reimbursement and any future repairs required. Management anticipates that general fund pay-go spending rather than debt will finance the district's subsequent, limited capital needs (about $500,000/year through fiscal 2019).

STATE PENSION FUNDING CONTRIBUTES TO MODEST CARRYING COSTS
The district participates in the Teacher Retirement System of Texas (TRS), a cost-sharing multiple-employer defined benefit plan. The state assumes the vast majority of Texas school districts' net pension liabilities and the corresponding employer contributions.

Like all Texas school districts, the district is vulnerable to future policy changes by the state, as evidenced by a relatively modest 1.5% of salary contribution requirement effective fiscal 2015. Legislative changes in 2013 increased the state's annual contributions, although it remains to be seen whether this improves TRS' ratio of assets to liabilities over time.

Under GASB 68, the district reports its share of the TRS net pension liability (NPL) at $5 million, with fiduciary assets covering 83.3% of total pension liabilities at the plan's 8% investment rate of return assumption (approximately 75% based on a more conservative 7% investment rate of return assumption). The NPL represents less than 1% of the district's fiscal 2016 market value. Other post-employment benefit (OPEB) contributions paid by the district are also nominal, as the state and employees also pay the bulk of these costs. Carrying costs for debt service, pensions and OPEB are manageable at 13% of fiscal 2016 governmental spending.

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 schoolchildren and was the second such ruling in the past two years, 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.

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 would likely follow with change intended to restore its constitutionality. Fitch would consider any changes that include additional funding for schools and more local discretion over tax rates to be a credit positive.