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

--$118.8 million ULT refunding bonds, series 2016.

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 Aug. 5, 2015.) Fitch also assigns an 'AA' underlying rating to the series 2016 bonds.

The 2016 bonds are scheduled to sell via negotiated sale the week of April 18. Proceeds will be used to refund certain outstanding maturities for savings and to pay issuance costs.

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 expectations for further expansion over the near-term are 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 debt service tax rate that is at the statutory cap of $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 Denton Independent School District's high debt levels and growth pressures.

GROWTH IN KEY DEBT METRICS: Continued enrollment growth pressures will produce capital needs in the future, but Fitch expects key debt ratios to remain stable or improve slightly due to the likely continuation of strong AV trends and the lack of near-term borrowing plans. Any further weakening of these debt metrics would not be consistent with the current rating level.

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 roughly 182,000 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 is low and improved further to 3.4% from 3.9% for the 12-month period ending January 2016 despite a roughly 3% 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 5% over fiscal years 2008-2016, reflective of largely ongoing, strengthening expansion that stalled for only one year during the recession. 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 27,685 students in fiscal 2016, which reflects a more moderate 2.5% year-over-year gain or about 665 students after a period of rapid growth at 4%-8% annually over fiscals 2006-2013. Actual student enrollment has remained largely on track with projections to date and the district's demographer projects a steady pace of 2%-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 seven fiscal years (fiscals 2009-2015). Historically conservative budgeting and spending practices have typically enabled actual operating performance in excess of expectations. The district posted positive net results in five of the last seven fiscal years, adding about $32 million (roughly 15% of fiscal 2015 spending) to total general fund balance from fiscal 2009 to fiscal 2015. These results were notable given changes in the funding formula and previously sizeable state budget cuts.

In addition, management 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 (unassigned reserves of no less than 15% of general fund spending and total general fund reserves at no less than 25%). Fitch views this practice as a positive credit consideration.

Audited fiscal 2015 results improved slightly upon mid-year budget assumptions. Operations resulted in modest $4 million surplus (2% of spending) with a total $5.1 million net addition to general fund balance, bolstered by the district's typical operating conservatism and slower actual pay-go capital spending during the year. Unrestricted general fund reserves totaled $81.5 million or about 38% of spending at fiscal 2015 year-end.

The adopted $223 million fiscal 2016 operating budget incorporated a modest gap ($2.1 million or 1% of spending). Spending rose about 5% from the prior year due in large part to additional staffing needs and pay increases to maintain competitive teacher salaries. The year's gap has subsequently widened to approximately $12 million or a moderate 5% of spending given the use of reserves for the completion of major maintenance projects, technology needs, and other non-recurring items as planned for in the assigned portion of reserves. General fund reserves are projected to remain strong despite the year's drawdown at roughly $70 million or 30% of spending at fiscal 2016 year-end.

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 at 12% of fiscal 2016 market value and $10,200 per capita while the pace of principal amortization is slow at 28% in 10 years. These ratios reflect the district's fast-growth environment and the related desire to meet facility demands while limiting the effect on existing taxpayers.

Debt service also consumes a high 21% of the fiscal 2015 operating and debt service spending (adjusted for refunded debt service). 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 the majority of 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 refunding is expected to provide relatively level savings of $2 million/year without extending or restructuring outstanding debt. Annual debt service is projected to peak at $63.5 million in fiscal 2017 and subsequently remain relatively flat at roughly $62 million over fiscals 2018-2033. The district exhausted its outstanding bond authorization in 2015, which will fund the construction of three additional school facilities planned to open over fiscals 2018-2020. Nonetheless, Fitch expects a future bond election in the near to intermediate term given ongoing enrollment gains, although district management has no firm plans presently.

STATE PENSION FUNDING CONTRIBUTES TO MODERATE CARRYING COSTS
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). 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 $30.8 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 18.2% of fiscal 2015 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.