AUSTIN, Texas--(BUSINESS WIRE)--Fitch Ratings affirms the rating on Tucson Unified School District No. 1, Arizona's (the district) outstanding debt as follows:
--$230.4 million unlimited tax general obligation (ULTGO) bonds at 'AA-'.
The Rating Outlook is Stable.
SECURITY:
The GO bonds are secured by an unlimited ad valorem tax levied against all taxable property within the district.
KEY RATING DRIVERS
FINANCES SATISFACTORY; STATE AID INCREASING: Management's attention to right-size operations and facilities has resulted in positive operating results the past three fiscal years. Reserves provide adequate internal liquidity support, offsetting the ongoing delay of year-end state aid payments. Nonetheless, the state of Arizona boosted fiscal 2014 K-12 funding, which will generate a modest increase in state aid for the district.
ECONOMIC RECOVERY UNDERWAY: A number of indicators suggest Tucson's economy is in the early stages of a modestly paced recovery. The regional economy remains diverse and relatively stable with a good mix of higher education, military, and government employment, largely offsetting credit concerns regarding traditionally below-average income levels.
TAX BASE DECLINES SOFTEN: As a lagging market indicator, secondary assessed valuations (SAV) declines have moderated as the regional economy has stabilized. Taxpayer concentration is moderate.
CONTRACTING ENROLLMENT BASE: District enrollment has steadily eroded; the declines have averaged approximately 3% over the past five years. This trend was reversed in the 2012-2013 school year by a very modest enrollment gain.
MODERATE LONG-TERM LIABILITIES: Debt levels remain moderate despite significant SAV declines. Capital needs appear manageable. Carrying costs are expected to remain moderate, supported by rapid debt amortization.
RATING SENSITIVITIES
MATERIAL CHANGE IN FINANCES, ENROLLMENT: Weakening of reserves below the modest amounts Arizona school districts are typically permitted to maintain would not be consistent with the rating category. Conversely, continued positive operating results, a stabilized management and political environment, and a sustained trend of measurable enrollment gains would be viewed positively.
CREDIT PROFILE
LARGE URBAN DISTRICT
Tucson is the second most populous city in Arizona. The district encompasses almost 230 square miles and provides public education to a sizable portion of the Tucson metropolitan statistical area (MSA). The Tucson MSA has roughly 1 million residents and experienced strong population increases over the past decade. Educational attainment is comparable to national levels while income/wealth levels fall about 20% below state and U.S. averages.
SATISFACTORY FINANCES THOUGH CASH FLOW PRESSURE REMAINS
The district's financial profile has been pressured in recent fiscal years by statewide cuts to state aid and delays to education funding beginning in fiscal 2009. Nonetheless, district finances have remained generally stable despite these state funding cuts and delays, as well as the reduction in funding associated with ongoing enrollment declines. Operations over fiscals 2011-2012 produced modest surpluses as reductions to state aid were mitigated in part by the use of about $18.3 million in one-time federal stimulus funds and by various cost-saving measures that cut instructional outlays sharply from fiscal 2010 totals.
For fiscal 2012, the district added a net $3.3 million to reserves, closing the year with an unrestricted fund balance of approximately $45 million or 14% of spending. Most of the year's positive fund balance was attributable to a large state receivable (Due From Other Governments) that rose to $64 million in fiscal 2012, up from $36 million recorded in fiscal 2011. According to management, the receivable spike was due to a one-time delay in the transmission of state funds to the Pima County Superintendent's Office and has since been rectified. Management also reports the delay did not necessitate additional short-term borrowing, as other internal fund balances provided adequate liquidity support. Management expects another delay (albeit a reduced amount) in receipt of the district's fiscal 2013 year-end $44 million state aid payment. However, delayed year-end payments are now typically received in full within the district's fiscal-year encumbrance period; this practice has been codified with recent state legislation requiring the final state aid payments to districts by July 15.
Fiscal 2013 general operational spending fell by about 4% on an adopted budget basis to $301.3 million compared to the prior year. The year's enrollment gain (approximately 200 students) generated additional state aid, which is anticipated to contribute towards a modest level of positive operating carry-forward (up to $2 million on a cash basis or about 1% of the budget revenue limit) into fiscal 2014. Management's year-end projections include spending levels largely below budget and positive but reduced fund balances on a cash basis used in part to offset the loss of federal stimulus funds and the reduction in other state revenue. Preliminary estimates of various fund balances that currently comprise the general fund on an audited basis (but are separately budgeted) total about $31 million on a cash basis or a healthy 10% of the year's adopted budget.
SCHOOL CLOSURES ASSIST IN ELIMINATING FISCAL 2014 BUDGET GAP
For fiscal 2014, management addressed a preliminary $17 million budget gap early on, most notably through the politically difficult decision to close some low-enrollment, small neighborhood schools. The district's decision to close 10 schools was recently approved by the federal court under the district's standing desegregation order and is projected to provide a one-time cost savings of $4.2 million with further savings to be realized in out years. Other key cost-saving measures that combined to close the budget gap included increased class sizes, a 5%-10% across the board reduction in non-school staffing levels, and some reduction to the district's health insurance contribution.
The adopted fiscal 2014 general operating budget totals $306 million and builds in a modest $2 million contingency reserve. The district will receive an additional $4 million in state funding, earmarked from K-12 education funds approved by the state legislature after the district's budget was adopted. Additional highlights for the budget year include a new superintendent and evidence of significant improvement in the district's compliance processes/procedures, as fiscal 2014 marks the first time in five years that the district is not the subject of a special state performance audit.
FUNDING FORMULA LIMITS DISTRICTS' FINANCIAL FLEXIBILITY
District funding is subject to the state's school funding equalization formula, which Fitch notes provides some revenue stability on a per pupil basis, but fairly modest local revenue-raising discretion and financial flexibility. Arizona school districts are limited by statute to maintain operating reserves at no more than roughly 4% of general spending. Larger reserve amounts must be used to reduce the next year's tax levy. School district spending is also largely controlled by the state through the annual expenditure budget, which is determined by formula and dictates the maximum amount of taxes districts can levy.
Property taxes now provide the larger portion of the district's total operating revenues (about 50% in fiscal 2012) while state funding contributes a reduced 44%, down from 62% in fiscal 2008. State budget pressures and SAV declines in recent years prompted the state to increase the qualifying tax rate, thereby shifting an increased portion of formula funding from the state to local taxpayers. Also, the district's property taxes include additional revenue generated through its tax levy allowed for desegregation purposes, which it will reportedly be able to continue to collect even after unitary status is achieved.
ECONOMIC RECOVERY UNDERWAY
Growth of the city of Tucson's residential base has slowed from its peak in 2001, when it recorded 3,800 single-family home permits; only 360 new housing permits are projected for fiscal 2013, but that number is up from 240 in fiscal 2011. Home prices also are showing improvement, with the most recent median and average sale prices registering double-digit percentage increases from a year ago.
Public and private investment in downtown Tucson has accelerated in recent months, due in part to the new street-car rail system that will extend from downtown to the university campus (scheduled to begin operations in 2014). City management reports nearly $800 million invested in various projects since 2008, with another $90 million projected for 2014. Over the near term, Global Insights projects the MSA will maintain a modest pace of economic recovery in line with the nation.
City unemployment declined on a year-over-year basis, falling slightly to 8.1% in June 2013 from 8.4% in June 2012 due to a moderate 2% loss in both labor force and employment. The city's June 2013 unemployment rate remained slightly below the state's at 8.5% while hovering slightly above the nation's rate of 7.8%. Services, military, higher education and government are the area's prominent employment sectors. The military presence in the Tucson area is substantial with the U.S. Army Intelligence Center, Fort Huachuca, and Davis-Monthan Air Force Base.
Public sector employment is led by state and local government agencies and public and higher education, including the University of Arizona main campus (estimated student population of 38,000), which employs roughly 11,000. Raytheon Missile Systems is the largest private employer in Tucson, also with a staff of 11,000. City management and local media report that the anticipated effects of federal sequestration on the Tucson economy are expected to be manageable, but with the large number of government and civilian contract workers in the local workforce, some effect is likely.
SAV DECLINES HAVE MODERATED
The district's tax base is mostly residential and moderately concentrated with the top taxpayers comprising 11% of the total. A local utility leads the top taxpayer list at 5%. Reflective of the slowly improving economy, SAV declines over the past two fiscal years lessened after the largest annual dip of 11% was recorded in fiscal 2012. The cumulative 25% SAV decline since fiscal 2011 has been significant, although Fitch notes this level of decline is below other parts of the state as the Tucson MSA housing market experienced less rapid rates of price appreciation. Initial estimates for fiscal 2015 SAV project another relatively modest decline, which Fitch believes is conservative based on recent positive economic trends.
Proposition 117 was approved by Arizona voters in November 2012 as a constitutional amendment, and will limit annual increases in existing property values to 5%, beginning in fiscal 2016 (2014 real property valuations). Fitch will continue to monitor the evolving impact of Proposition 117 as it reflects a significant change to the property assessment process.
DIRECTION OF ENROLLMENT UNCERTAIN
The district's relatively large enrollment base has realized a steady pattern of annual decline since 2007, due in part to other educational choices offered in the area. Nonetheless, a very modest enrollment gain of about 200 students or less than 1% reversed this trend in fiscal 2013 with average daily membership totaling 48,212. Management anticipates that its marketing efforts, the district's improved school testing scores, and a free pre-K program should sustain and ultimately boost district enrollment, a prospect Fitch believes has a reasonable chance of success.
MODERATE DEBT AND OTHER LONG-TERM LIABILITIES
Overall debt levels are moderate at 2.9% of fiscal 2014 full market value or approximately $1,440 on a per capita basis. Fitch believes the district's capital needs are manageable given recent enrollment trends. The district maintains sufficient capacity in existing school facilities even after recent school facility closures and has no near-term plans for additional closures at this point. District officials report preliminary plans to approach voters over the near term for about $250 million in GO bond authority to address a variety of technology and facility renewal needs. The program would be expected to address capital needs for roughly the next 10 years.
The district's pension plan, as well as death, disability and health insurance benefits, is through the Arizona State Retirement System (ASRS). The district has made 100% of its annually required contribution (ARC) for fiscal years 2010-2012 as directed by the state, equivalent to approximately $27 million in fiscal 2012.
The actuarially funded position for ASRS as of June 30, 2012 was satisfactory at 75.7% using the state's 8% assumed rate of return. However, estimated funding of the state administered program falls below 70% when a more conservative 7% investment return is assumed. Carrying costs for debt service, pension and other post-employment benefits (OPEB) through ASRS were moderate at 15.3% of fiscal 2012 governmental spending and little change is expected over the near term even with probable pension ARC increases.
Additional information is available at 'www.fitchratings.com'.
In addition to the sources of information identified in the report 'Tax-Supported Rating Criteria', this action was additionally informed by information from Creditscope and IHS Global Insight.
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:
U.S. Local Government Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314
Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=802003
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