Fitch Downgrades South San Antonio ISD, TX's ULT Bonds to 'A+'; Outlook Stable

Fitch Ratings takes the following rating action on South San Antonio Independent School District, Texas' (the district) unlimited tax (ULT) bonds:

--$136.1 million ULT bonds downgraded to 'A+'.

The Rating Outlook is revised to Stable from Negative.

SECURITY

The bonds are direct obligations of the district, secured by an unlimited tax pledge levied against all taxable property within its boundaries.

KEY RATING DRIVERS

WEAKENED RISK PROFILE; MANAGEMENT CONCERNS: The downgrade primarily reflects several years of operating deficits weakening the district's risk profile. The 'A+' rating also reflects significant leadership turnover, a weak debt profile expected to worsen, low wealth indices, and the overall restrictive revenue raising environment.

WEAK FINANCIAL OVERSIGHT: The state is investigating the district regarding its controls and oversight of bond program procurement and spending. Fitch does not believe the investigation poses a threat to the district's credit profile, but that it reflects weak financial oversight.

FINANCES APPARENTLY STABILIZING: The Stable Outlook reflects the district's expected return to budget balance given some modest spending adjustments and improved state funding levels. Residual fund balance after a string of budget deficits provides a still-sound fiscal cushion.

HIGH DEBT BURDEN, AFFORDABLE FIXED COSTS: Total outstanding debt-to-market value is very high and will remain elevated given additional capital needs and the slow amortization. However, carrying costs for debt service and retiree benefits are very affordable due to state support for these long-term liabilities.

MIXED SOCIO-ECONOMC PROFILE: San Antonio's economy is large and diverse with strong growth prospects and a low unemployment rate. This credit positive is balanced against the district's concentrated resource base with very low wealth levels.

RATING SENSITIVITIES

STABILITY IN FINANCES: The Stable Outlook reflects Fitch's expectations that the district will retain a sound fiscal cushion over the near term, which mitigates the risks related to the high debt burden and leadership challenges.

CREDIT PROFILE

This primarily residential district comprises 21 square miles in the southwest part of San Antonio (GO bonds rated 'AAA' with a Stable Outlook by Fitch). Average daily attendance has fluctuated in recent years and remains just below 9,000.

LEADERSHIP GAPS, FRAGILE POLITICAL DYNAMICS ARE CONCERNS

The district has had five superintendents in the past three years and a general difficulty in achieving consensus for planning purposes and personnel decisions. An improved state funding environment has improved the budget outlook for the district in the near term, but Fitch's confidence in management's ability to address future budgetary issues is undermined by the elevated degree of political contentiousness, lack of continuity in the superintendent position, and absence of institutionalized policies. In addition, the district operates in a restrictive revenue-raising environment, whereby voters must approve any tax rate increase for operational purposes.

LIMITED LOCAL RESOURCE BASE; SUBPAR SOCIO-ECONOMIC INDICES

District wealth indicators are well below average, with per capita income at 48% of the national average, per capita market value at a low $36,000, and a poverty rate (21%) that exceeds the national average (14%). The district's tax base is also concentrated, with the top 10 payers providing an above-average 20.7% of fiscal 2014 taxable assessed valuation (TAV). The top payers include a mall and Boeing Aerospace (long-term Issuer Default Rating of 'A' with Stable Outlook).

The district's recent TAV trend has been positive, with stabilized housing prices, positive re-appraisals, and development activity producing a 2.6% compound growth rate over the past five years. Prospects for continued growth are favorable given anticipated development adjacent to a Texas A&M University satellite campus and expansion of the regional economy.

STRONG RESERVES HAVE DECLINED BUT REMAIN SATISFACTORY

Recurring operating deficits from fiscal years 2009-2012 and in 2013 (unaudited) resulted from structural budget imbalance that was caused by increases to staffing levels in prior years that outpaced enrollment growth that was exacerbated by state funding cuts beginning in fiscal 2012. The annual deficits (2%-3% of spending) have typically been lower than the originally budgeted deficits, but have produced a cumulative 23% decline in operating reserves during this five-year period. Unrestricted general fund balance concluded fiscal 2012 at $18.3 million or 24% of spending. The district lacks a formal fund balance policy but unrestricted reserves are below the current administration's working target of 25% of spending.

Management addressed the magnitude of the deficits with a hiring freeze, cuts to discretionary spending, a retirement incentive, and significant use of attrition. Despite a balanced fiscal 2013 budget, the district expects a small $0.6 million deficit to conclude fiscal 2013 due to revenue shortfalls. Fund balance is projected to decline by a commensurate amount; the unrestricted portion would remain above 20% of spending.

2014 BUDGET BALANCED; OUT-YEAR FORECASTS FAVORABLE

The adopted general fund budget for fiscal 2014 is balanced with slightly higher appropriations supported by a $2 million net revenue gain from higher state funding levels. Management anticipates a positive operating margin to conclude the year based on lower than budgeted spending.

Fitch views positively the return to budget balance in fiscal 2014, as well as revised budget forecasts that now demonstrate budget balance through fiscal 2017 and maintenance of sound operating reserves at around current levels (above 20% of spending). The key to the reversal of deficit projections is the improved state funding environment. Fitch views the assumptions underlying the forecasts as reasonable: a 0% enrollment growth rate, level tax rate, and increased pension costs.

CENTRALLY LOCATED IN SAN ANTONIO MSA

The district's location in the broad and diverse San Antonio economy is a credit positive. San Antonio is the second largest city in the state and eighth largest in the nation, with an estimated population of 1.8 million. The San Antonio market shed jobs in 2010 as a result of the national recession but has since recovered most of the job losses. The region has experienced considerable growth in the hospitality and energy sectors, the latter being driven by drilling activity in the expansive Eagle Ford shale gas formation south of the city, which has kept the jobless rate low at 5.8% in October 2013.

HIGH DEBT BURDEN MAY RISE FURTHER

Overall district debt represents more than 16% of market value. This debt calculation includes the currently accreted interest of outstanding capital appreciation bonds. However, debt per capita is moderate and the district receives direct aid from the state for debt service as a result of its low property wealth, which keeps servicing costs very affordable at only 4.4% of governmental fund spending in fiscal 2012.

Debt levels will likely remain elevated due to slow principal amortization (34% retired in 10 years) and future capital needs. Management previously communicated its intent to seek debt authorization from voters in the range of $30 million-$50 million as early as November 2013, but this proposition has been delayed, partly as a result of the turnover of district leadership. The future bond program would fund construction of a new elementary school and major renovations to aging facilities. Continued growth in the tax base will be critical to supporting debt plans and mitigating the impact to the tax rate.

RETIREE LIABILITIES NOT A CREDIT PRESSURE

Retiree pension and healthcare benefits are provided to employees through the Teacher Retirement System of Texas (TRS), a cost-sharing multiple-employer plan. TRS is adequately funded at 81.9% as of Aug. 31, 2012, though Fitch estimates the funded position to be lower, at 73.8% when a more conservative 7% return assumption is used.

Other post-employment benefit (OPEB) contributions paid by the district are nominal, as the state and employees also pay the bulk of these costs. Total pension and OPEB contributions made by the district in fiscal 2013 totaled a very low 0.9% of governmental fund expenditures. The state's payment of district legacy costs is an important credit strength as it keeps overall carrying costs reasonable in the face of a high and potentially growing debt burden. Starting next fiscal year (2015), pension contributions for all districts in the state will rise to 1.5% on the statutory minimum portion of payroll from zero, increasing carrying costs. Increases in district funding requirements beyond fiscal 2015 could create additional budget pressure.

TEXAS SCHOOL DISTRICT LITIGATION

In February 2013, a district judge ruled 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 school children, found the system 'inefficient, inequitable, and unsuitable and arbitrarily funds districts at different levels...' The judge also cited inadequate funding as a constitutional flaw in the current system.

The judge reopened the lawsuit in June 2013 after state legislative action that partially restored state funding levels and made other program changes. The trial is scheduled to begin this month (January 2014). If the state school finance system is ultimately found unconstitutional, the legislature will be directed to make changes to the system to restore its constitutionality. Fitch would consider any changes that include additional funding for schools a positive credit consideration.

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

In addition to the sources of information identified in Fitch's Tax-Supported Rating Criteria, this action was additionally informed by information from Creditscope, University Financial Associates, S&P/Case-Shiller Home Price Index, IHS Global Insight, National Association of Realtors.

Applicable Criteria and Related Research:

--'Tax-Supported Rating Criteria' (Aug. 14, 2012);

--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 14, 2012).

Applicable Criteria and Related Research:

Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

U.S. Local Government Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314

Additional Disclosure

Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=815241

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