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

--$38.6 million unlimited tax (ULT) school building bonds, series 2016A;
--$22.4 million ULT refunding bonds, series 2016B.

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 PSF, see 'Fitch Affirms Texas PSF Rating at 'AAA'; Outlook Stable', dated Aug. 5, 2015).

Fitch has also assigned an 'AA-' underlying rating to the series 2016A and 2016B bonds and to the $12.9 million series 2016C ULT refunding bonds. Fitch has affirmed the 'AA-' underlying rating on the district's $321.9 million (pre-refunding) in outstanding parity bonds.

The bonds are scheduled to sell the week of April 4 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 2016A, 2016B, and 2016C bonds are payable from an unlimited property tax levied against all taxable property within the district. The series 2016A and 2016B ULT bonds are also insured as to principal and interest repayment from a guaranty provided by the PSF.

KEY RATING DRIVERS

STRONG RESERVES MAINTAINED: Fitch expects the district's fiscal cushion to remain strong despite required, multi-year tax repayments. 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: A high unemployment rate and low wealth indices characterize the limited local economy.

TAV DECLINE: Reduced valuation from successfully protested industrial properties resulted in moderate TAV declines 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 given issuance plans and recent TAV trends. Slow principal amortization underpins management's goals of utilizing new bond authority while minimally increasing the debt service tax rate. Moderate carrying costs are largely attributable to the significant role played by the state in funding pensions.

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 8,030 students in 2016, reflective of flat to slightly declining enrollment base. Management projects ADA will remain relatively flat over the next several years.

STRONG RESERVES MAINTAINED DESPITE TAX REPAYMENTS
The district's financial position remains strong despite the recent effect of two separate property tax disputes between the district's second largest taxpayer, Valero Energy (Valero; formerly Premcor), 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 residual $8.5 million liability will be paid as planned over three additional fiscal years ($3 million each in fiscal 2015 and 2016, and $2.5 million due in fiscal 2017).

The second lawsuit, 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 the district sourced the May 2015 (fiscal 2015) payment solely from the general fund. The district was reimbursed $5.3 million by the state to offset the $13.5 million tax rebate.

Fiscal 2015 operating performance was roughly break-even before $9.8 million of reserves (14% of spending) were drawn down as planned for the year's required property tax repayments. Nonetheless, unrestricted general fund balance totaled $29.4 million or a still strong 35.4% of spending at fiscal 2015 year-end. Liquidity in the general fund remained strong as well at $26 million or nearly four months of fiscal 2015 spending.

The fiscal 2016 $74.4 million operating budget was adopted as structurally balanced. Use of reserves was also budgeted, primarily to address the year's planned property tax repayment ($5.6 million or 7.5% of spending). Management currently indicates operations should produce a modest surplus given projected salary savings. Lagged receipt of additional state aid (a result of prior years' reduced valuations) is anticipated to largely offset the impact of the year's property tax repayment. General fund reserves are currently estimated to be maintained at a stable $30 million or a strong 40% of spending according to management.

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. Management's evidenced ability to maintain structurally balanced operations in order to preserve its fund balance offsets some of this concern. Although Fitch believes the district's general fund reserve levels provide an adequate cushion to absorb the tax rebate liability currently due (estimated at $2.5 million in fiscal 2017), recurring revenue losses arising from a negative outcome could erode financial flexibility and result in negative rating action.

HEAVY TAX BASE CONCENTRATION IN THE ENERGY & CHEMICAL SECTORS
Taxpayer concentration is a credit concern; the top 10 taxpayers 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 2015 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 and again by a more modest 2% in fiscal 2016. These declines were due primarily to the reduced values stemming from the aforementioned, successful tax protests. A modest portion of the fiscal 2016 valuation decline, however, was also attributable to lower fuel prices and a subsequently reduction in industrial inventory values. 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 $156,000, making this a property-rich district under the state's funding framework. Despite the classification, the district is not required to make equalization payments to the state 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 high at 5.1% of market value and $8,010 per capita. Amortization of direct principal is slow with around 31% retired within 10 years. The new money portion of this issuance is the second part of a $195 million bond authorization approved by voters at a strong 68% margin in November 2014. Full use of the remaining authorization is presently projected over the next few years. Management anticipates these plans should allow for some TAV growth and maintenance of the debt service tax rate in line with the small increase promised voters to no more than $0.32 per $100 TAV.

STATE PENSION FUNDING CONTRIBUTES TO MODERATE 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 $10.4 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 remain moderate at 19.2% 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.