Sept 13 - Fitch Ratings assigns an ‘AA’ bank bond rating to the following Denton Independent School District, Texas bonds corresponding with the substitution of the district’s liquidity provider in the form of a standby bond purchase agreement (SBPA): --$30 million variable rate unlimited tax (ULT) school building bonds, series 2006-B. The district switched its SBPA to Wells Fargo from Bank of America effective Aug. 24, 2012. At that time Fitch upgraded the short-term rating on the bonds to ‘F1+’ from ‘F1’. In addition, Fitch affirms the ‘AA’ underlying rating on outstanding parity ULT bonds. The Rating Outlook is Stable. SECURITY The bonds are secured by an unlimited ad valorem property tax pledge on parity with the district’s outstanding ULT bonds. The bonds also carry a guarantee from the Texas Permanent School Fund (PSF), whose bond guaranty program is rated ‘AAA’ by Fitch. KEY RATING DRIVERS ROBUST FINANCIAL CUSHION: Strong financial performance, aided by conservative budgeting practices, has yielded ample reserves and liquidity. DIVERSE ECONOMY; EXPANDING TAV: The district’s growing tax base benefits from its proximity to the healthy Dallas-Fort Worth (DWF) metropolitan area economy which continues to gain employment, population and income. NEGLIGIBLE DEBT FLEXIBIILTY: 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 - which is very close to the state’s statutory test for new debt issuance - limits capital flexibility. BANK BOND TERMS MANAGEABLE: The terms of the SBPA governing liquidity support of the bonds could pressure the district’s finances if the bonds were to become bank bonds for a sustained time period or in the event of acceleration. However, Fitch believes that that district’s strong financial profile and implied market access to take out such bonds with long-term debt mitigates some of these concerns. CREDIT PROFILE BANK MODE PROVISIONS Fitch has reviewed the interest rates, default and acceleration provisions, and the amortization schedule specified in the documents governing the bonds. Under the terms of the SBPA, the district would be required to amortize potential bank bonds over a five-year period at the prescribed bank interest rate. The condensed amortization schedule and higher interest cost when in bank mode could pressure the district’s finances, but Fitch believes the district’s robust liquidity and implied market access to take out such bonds with long-term debt mitigate some concern about the potential pressures. At present, there are no bank bonds outstanding. Acceleration of payment on the bank bonds would occur in the events of default specified in the SBPA, namely downgrades to the PSF (to below ‘A/‘A2’) or the debt of the district if the PSF is not in effect (to below ‘A-'/‘A3). However, the occurrence of credit related acceleration events are sufficiently mitigated by the high rating levels of the PSF and district parity obligations. SOLID FINANCIAL PERFORMANCE, RESERVES, & LIQUIDITY Financial performance has remained strong despite the continuing capital and operating pressures associated with rapid enrollment growth. The district outperformed its 2011 deficit budget in the areas of attendance-based state aid and local property tax revenues to produce an $8.2 million operating surplus after transfers (4.6% of spending). The unrestricted general fund balance (committed, assigned and unassigned balances per GASB 54) rose to a robust $63.2 million, or 34% of operating expenditures and transfers out, and year-end cash & investments exceeded five months of operating costs. State budget cuts in fiscal 2012 resulted in the district receiving $11.5 million less in state formula-funding than anticipated but management reduced spending sufficiently to adopt a balanced budget and now expects to add at least $12 million to fund balance (a 19% increase). The original budget eliminated 7% of personnel via attrition, froze salaries, and reduced departmental spending. Approximately $4 million in one-time federal aid was prudently excluded from the operating budget, and this revenue, together with better than forecast property tax collections, other federal aid, and ongoing cost savings, triggered the significant surplus after transfers. The 2012 surplus would mark the third consecutive year of positive results and available fund balance above 30% of expenditures. The fiscal 2013 $197 million general fund budget increases spending 4.5% from the prior-year budget and calls for a modest $2.8 million use of fund balance, in part due to the second year of state budget cuts and a 3% pay-raise for staff. Fitch draws comfort from the district’s history of outperforming budget expectations and still-ample reserves net of the forecast draw-down. HIGH DEBT RATIOS STEM FROM ENROLLMENT-DRIVEN CAPITAL NEEDS The district’s debt profile is Fitch’s key credit concern. Overall debt ratios and the annual debt burden on the budget are high while the pace of principal amortization is slow, reflecting the district’s fast-growth environment and related needs to meet facility demands while attempting to limit the effect on existing taxpayers. Overall debt levels comprise a very high 10.7% of market value and $7,887 per capita and are slightly higher when accreted interest from capital appreciation bonds (CABs) is included. The high overall debt load is a function of the direct debt, and large amount of debt from the city of Denton and various fresh water supply districts. Debt service also consumes a high 20% of the fiscal 2012 operating and debt service fund budgets. The district’s debt portfolio contains about 18% of mostly hedged variable rate debt, which Fitch views as an acceptable range for the ‘AA’ rating category. However, given the high debt service burden this concern is somewhat elevated. TIGHT MARGIN ON 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 ($0.49 per $100 TAV) that is very near the state’s statutory limit for new debt issuance ($0.50). The district has $76 million in remaining debt authorization for new campuses and officials do not plan to issue this debt unless it can be supported by the current tax rate. The tax rate cap for new money debt somewhat mitigates the risk of sharp increases in debt levels over the near term but may also constrain the district’s ability to meet capital needs, absent sufficient tax base growth. DIVERSE & GROWING LOCAL ECONOMY ENHANCED BY PROXIMITY TO DFW METRO AREA 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. Proximity to the DFW metro area and the access provided by major highway, air, and rail transportation have attracted a variety of industry and business to the area, and an expanding service sector and manufacturing development continues to diversify the district’s mostly residential tax base. Education and health services top the list of major area employers, offering a measure of stability during the economic downturn. 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 6.8% from 7.6% for the 12-month period ending June 2012 and has trended consistently below area, state, and national rates. TAX-BASE GROWTH CONTINUING The district’s TAV grew by a 2.4% compound annual growth rate from 2008-2012 and is up nearly 4% for fiscal 2013. While growth remains significantly slower than the double-digit rate seen prior to 2009, Fitch believes prospects for continuing modest growth are positive given the development occurring within the district, the stable housing market, and growing regional economy. Population and enrollment gains, which were significant over the past decade, are also continuing. Enrollment has increased annually by about 1,000 students (5%) over the past five years to just under 25,000, and the district projects continuing enrollment gains at between 800-1,000 annually over the next five years.