September 14, 2016 - 3:43 PM EDT
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Fitch Rates Port Arthur ISD (TX) $25.2MM Series 2016D and $52.5MM 2016E ULT Rfdg Bonds 'AA-'

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

--$25.2 million ULT refunding bonds, series 2016D;

--$52.5 million ULT refunding bonds, series 2016E.

The bonds are scheduled to sell Oct. 4th via negotiated sale. Proceeds will be used to refund certain outstanding maturities for savings and to pay related costs of issuance.

In addition, Fitch has affirmed the district's Issuer Default Rating (IDR) at 'AA-' and the 'AA-' rating on the approximately $362.2 million (pre-refunding) in outstanding parity bonds.

The Rating Outlook is Stable.

SECURITY

The bonds are payable from an unlimited property tax (ad valorem) pledge levied against all taxable property within the district.

KEY RATING DRIVERS

Underpinning the 'AA-' IDR and unlimited tax (ULT) ratings is the district's adequate financial resilience and strong gap-closing capacity that Fitch believes will be maintained throughout the economic cycle, primarily a result of its sound labor cost flexibility. The district's slowly amortized and rising debt service schedule drives the majority of its moderately high carrying costs. The overall long-term liability burden is elevated but still in the moderate range.

Economic Resource Base

The district serves primarily the city of Port Arthur, which is part of the Beaumont-Port Arthur metropolitan statistical area (MSA), a three-county region in southeast Texas located along the upper Gulf Coast. Much of the local economy is driven by a long-standing, concentrated base of petroleum-related industries and its limited nature is apparent in the city's weak socio-economic metrics that include high unemployment and low wealth/educational attainment levels. District population (estimated at 54,550 in 2016) has grown modestly in the last few years, which Fitch believes is a likely result of added employment opportunities from the area's large industrial construction projects.

Enrollment declines have moderated. A 1% average annual enrollment decline was realized over fiscals 2005-2015, which roughly halved the rate of decline over fiscals 2002-2012. This relative improvement in recent enrollment performance underpins Fitch's expectation of a similar enrollment trend to be sustained. Enrollment totaled 8,972 in fiscal 2016.

Revenue Framework: 'bbb' factor assessment

The district's independent legal ability to raise revenues is limited by state law according to the school funding system. Fitch believes growth prospects for revenues remain solid, comparable to historical trends, due to the likelihood of further assessed valuation growth and the ability of district property taxes to capture that growth. However, this assessment is diminished by district's recent history of sizeable and successful tax protests requiring repayment, recent taxable assessed value (TAV) decreases in a highly concentrated tax base, and Fitch's expectations of continued, modest enrollment decline.

Expenditure Framework: 'aa' factor assessment

Enrollment is a key driver of both revenue and expenditure trends, which should keep the pace of spending generally aligned with revenues over time. Expenditure flexibility is adequate; the district's ability to adjust labor costs if needed is balanced against its moderately high carrying costs.

Long-Term Liability Burden: 'aa' factor assessment

The district's long-term liability burden is elevated but still in the moderate range in relation to the local resource base. Continued, modest population growth should keep future debt and capital needs manageable and in line with the 'aa' assessment.

Operating Performance: 'aa' factor assessment

Sound flexibility in its labor costs and historically solid revenue growth underpin the district's demonstrated operating flexibility, allowing for a high level of reserves to be maintained. Fitch believes the district's operating cushion would remain adequate and in line with the 'aa' assessment in a moderate economic decline.

RATING SENSITIVITIES

Financial Flexibility: The rating is sensitive to the district's ability to maintain an adequate level of operating flexibility in light of a controlled revenue environment (pursuant to the state's funding formula) and the district's specific vulnerability to sizeable tax protests by large industrial taxpayers.

CREDIT PROFILE

Large industrial properties dominate the district's tax base, most of which are involved in the energy and chemical sectors. Home to a large portion of United States' refining capacity, the area continues to attract significant industrial investment. Key contributing factors include the area's extensive energy and pipeline infrastructure as well as proximity to transportation/shipping networks that include the Port of Port Arthur, one of Texas' leading seaports.

Recent development includes Sempra Energy's announcement of plans for a LNG natural gas liquefaction facility in Port Arthur. This project, in addition to other large projects underway, such as the nearby Golden Pass LNG terminal (estimated at $12 billion in value at completion) is expected to bolster population and employment trends.

High taxpayer concentration in terms of industry composition and among individual taxpayers in addition to some volatility in the district's property tax base is also a result of the outsized impact of the petrochemical sector. This lack of diversity constitutes a measure of risk to the district. The top 10 taxpayers comprise about 30% of TAV in fiscal 2016 with Premcor (Valero) Refinery as the leading taxpayer at 12% of fiscal 2016 TAV, followed by the Motiva refinery at 10% of TAV.

The district's historically strong annual tax base growth was largely a result of capital improvements and expansions to refineries made by various top taxpayers. Moderate TAV decline in the last three fiscal years (fiscals 2015-2017) is primarily attributable to reduced valuation from successfully protested industrial properties as well as lower fuel prices and a subsequent reduction in industrial inventory values. Currently, management reports there are no pending or outstanding tax protests. Fitch believes the essentiality of oil and gas refining in the U.S. makes the closure of these plants unlikely, but expects the district's exposure to TAV volatility to continue. Modest TAV growth appears likely given further industry investment planned or underway.

Revenue Framework

Funding for public schools in Texas is provided by a combination of local (property tax), state and federal resources. The state budgets the majority of instructional activity through the Foundation School Program (FSP), which uses a statutory formula to allocate school aid taking into account each district's property taxes, projected enrollment, and amounts appropriated by the legislature in the biennial budget process. The majority of districts are funded using a target revenue approach, whereby the combination of local and state funding for operations meets a predetermined per pupil amount (which varies from district to district). This third-party funding support for operations stems from the long-standing commitment of the state to fund K-12 education. Nonetheless, this revenue stream remains susceptible to changes in local enrollment trends and recessionary pressures on state revenues.

About 60% of the district's general operating revenues come from local property taxes. The district is considered property-rich under the state's funding framework due to its expansive industrial base, although it is not required to make equalization payments to the state presently. District property tax revenues stem from a highly concentrated tax base. Fitch recognizes these revenues remain vulnerable to further assessment appeal activity by individual taxpayers, which can have a magnified impact on revenue loss, not fully offset by additional state aid due to the district's above-average property wealth.

Fitch expects revenue gains to be solid and in line with historical trends--above the rate of inflation, but below U.S. GDP. Additional economic expansion should drive these gains, although sizeable tax repayments, recent TAV decreases, and Fitch's expectations of continued, modest enrollment decline weigh on the assessment.

The district has almost no ability to independently increase its operating revenues. Per state statute, the district cannot increase its operating property tax levy ($1.04 per $100 TAV) further unless it receives voter approval. The district levied a separate, unlimited debt service tax rate of approximately $0.31 per $100 TAV in fiscal 2016.

Expenditure Framework

Instruction consumed about 60% of operational spending in fiscal 2015. Fitch expects enrollment to trend with a similar, modest decline, which should keep spending pressures manageable and more or less aligned with the expected solid pace of revenue growth over time.

The district has demonstrated its ability to adjust staffing and class sizes in order to control key expenditure items in times of fiscal stress without affecting its educational goals. This is tempered by the district's need to maintain a competitive salary structure in order to recruit and retain highly educated professionals. Nonetheless, management's legal control of labor costs and headcount remains strong.

The district's fixed carrying costs, which are largely a product of annual debt service costs, weigh on this assessment. The combination of total annual debt service, the contractually required annual pension funding amount, and the annual actual spending for other post-employment benefits (OPEB), net of state support - consumed a moderately high 19% of fiscal 2015 governmental spending. Fitch expects these fixed costs will slowly rise going forward as a result of projected debt service and future debt planned. Annual debt service is currently estimated to peak at roughly $25 million (about 22% of fiscal 2015 governmental spending). Nonetheless, these costs should remain comparable to the 'a' assessment. District capital needs remain manageable, evidenced by an extended timeframe to utilize $50 million in remaining ULT bond authorization, as well as low retiree costs that reflect primary state funding of this expense.

Long-Term Liability Burden

The long-term liability burden is moderately elevated at approximately 20% of personal income, primarily attributable to the district's direct debt levels. However, Fitch believes this metric somewhat overstates the burden given the significant property wealth inherent in the district's large industrial base that also underpins the long-term liability burden. Roughly 85% of the overall burden is derived from the district's direct debt (roughly $354 million post-refunding) and principal amortization is slow (about 30% retired in 10 years). Fitch believes the overall liability burden should remain consistent with an 'aa' assessment as the recent trend of modest population growth should support manageable future debt and capital needs.

A portion of this refunding issuance provides up-front savings in order to preserve the district's debt service tax rate at just under $0.32 per $100 TAV as promised voters. The district maintains ample flexibility under the state-imposed $0.50 per $100 TAV cap for new money issuance.

The district participates in the Texas Teachers Retirement System (TRS), a cost-sharing, multiple-employer plan for which the state provides the bulk of the employer's (the district) annual pension contribution. Recent reforms have lowered benefits and increased statutory contributions in order to improve plan sustainability over time.

Under GASB 67and 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 assumption (approximately 75% based on a more conservative 7% investment rate assumption, for a liability of $17 million). The NPL adjusted for a 7% interest rate assumption remains small at less than 1% of personal income. The district also provides OPEB through the state-run, post-employment benefit healthcare plan.

Participants' required pension contributions are based on a statutory formula that consistently falls short of the actuarially-determined amount. Fitch therefore expects there will be modest growth in the NPL even if investment returns meet assumed rates, although not outside of expectations for the 'aa' assessment given how small the pension liability is relative to overall debt. Like all Texas school districts, Port Arthur ISD is vulnerable to future policy changes that shift more of the contributions and liabilities onto districts, as evidenced by a relatively modest 1.5% of salary contribution requirement effective fiscal 2015.

Operating Performance

Fitch would expect the district to use a balanced combination of its sound labor cost flexibility and historically strong reserve levels to maintain an adequate level of operating financial flexibility throughout the economic cycle.

The fiscal discipline and strong budgetary practices of district management has allowed for balanced operations and high reserves to be maintained despite the occurrence of required, multi-year tax repayments in recent fiscal years. 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. Unrestricted general fund balance totaled $29.4 million or 35.4% of spending at fiscal 2015 year-end.

The modest operating surplus projected in fiscal 2016 is planned for use on various one-time spending priorities in fiscal 2017, inclusive of performance incentives, which should keep the district's fiscal 2016 year-end cushion at no less than that of the prior fiscal year ($30 million or approximately 35% of spending).

The approximately $70 million fiscal 2017 operating budget is structurally balanced and down by about 5% or $4 million year-over-year, largely a result of tighter staff budgeting that eliminated most of the district's currently unfilled positions.

Additional information is available at 'www.fitchratings.com'.

In addition to the sources of information identified in the applicable criteria specified below, this action was informed by information from Lumesis and InvestorTools.

Applicable Criteria

U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)

https://www.fitchratings.com/site/re/879478

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1011687

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1011687

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Fitch Ratings
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Source: Business Wire (September 14, 2016 - 3:43 PM EDT)

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