OREANDA-NEWS. Fitch Ratings has affirmed the following ratings of South San Antonio Independent School District at 'A+':

--$108.9 million in outstanding unlimited tax (ULT) bonds;

--the district's Issuer Default Rating (IDR).

The Rating Outlook is revised to Negative from Stable.

SECURITY

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

KEY RATING DRIVERS

The Outlook revision to Negative reflects Fitch's concern that weak governance could continue a trend of spending well in excess of stagnant revenue prospects, diminishing the district's currently sound level of reserves and operational flexibility. Fitch expects the district's long-term liability burden to remain elevated but moderate over the medium term.

Economic Resource Base

This primarily residential district comprises 21 square miles in southwest San Antonio (IDR 'AAA'/Outlook Stable). Population and enrollment were about 47,900 and 9,800 in fiscal 2016, respectively, and have both declined in recent years.

Revenue Framework: 'bbb' factor assessment

Fitch expects stagnant revenue growth based on projections of continued enrollment declines. The district's legal ability to raise revenues is limited by state law.

Expenditure Framework: 'aa' factor assessment

Deferred capital needs and increasingly underutilized facilities produce a pace of spending growth above expected revenue growth. Low carrying costs and a lack of collective bargaining provide a solid degree of expenditure flexibility.

Long-Term Liability Burden: 'a' factor assessment

The long-term liability burden is moderately elevated. Fitch expects the burden will remain in this range given identified capital needs, slow amortization of direct debt, and the district's weak personal income trend.

Operating Performance: 'a' factor assessment

Large, unbudgeted costs in recent years have reduced reserves that provide important financial flexibility through the economic cycle, and the state has appointed a conservator to oversee the district's governance and management. Fitch believes that the district's recent financial trends could result in some nonrecurring support of operations in a revenue downturn.

RATING SENSITIVITIES

Diminished Financial Flexibility: A trend of spending that outpaces revenues could lower the district's reserve safety margin, depleting gap-closing capacity and pressuring the rating.

Weak Financial Oversight: The district has been the subject of state investigations into financial processes and controls. Fitch believes that recent corrective actions provide stability to these processes, but further negative findings could result in a weaker financial position and lead to a rating downgrade.

CREDIT PROFILE

The district's location in the broad and diverse San Antonio MSA is a credit positive, as the region has experienced considerable job growth and overall economic expansion. Although the city has little direct exposure to mineral property, San Antonio's proximity to the Eagle Ford shale formation in south Texas presents some economic risk from oil and gas price fluctuations.

The district's tax base has experienced robust compounded annual growth of 5.8% over the past five years due to stabilized home prices and positive reappraisals despite limited new construction. The base is somewhat concentrated, with the top 10 payers representing 18% of taxable assessed value (TAV), led by a shopping mall at 4.6%. Wealth metrics in the district are below the MSA, state, and U. S. averages.

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 targeted revenue approach, whereby the combination of local and state funding for operations meets a predetermined per pupil amount (which varies from district to district). Approximately 70% of district operating revenues come from state aid, followed by property taxes at nearly 20%.

General fund revenues grew at a compound annual growth rate of 1.9% over the 10 fiscal years ended 2014, performing at a rate slower than U. S. economic performance and inflation. This slow growth is largely reflective of the district's weak enrollment trend, which is a key component of the state funding formula. Future growth prospects for operating revenues are stagnant, based on district projections of continued enrollment declines over the medium term.

The district's independent legal ability to raise revenues is limited, as the current operating tax rate of $1.04 per $100 of TAV is at the statutory limit. An increase to a maximum of $1.17 would require voter approval. The district levies a separate unlimited tax rate of $0.41 per $100 of TAV for debt service, although the state enforces a debt service rate cap of $0.50 for new bond issuance.

Expenditure Framework

The district spends the majority of its budget on instruction, and also funds approximately $1.1 million of capital outlay annually (1.3% of fiscal 2015 expenditures). However, a number of unbudgeted costs have arisen in recent years in response to litigation, state investigations, and unanticipated facility repairs.

The district's 2015 facility study reports an oversize proportion of underutilized facilities. This factor, combined with a declining enrollment trend and the district's history of large, unplanned spending items produces a natural pace of spending above expected revenues.

The district retains a solid degree of expenditure flexibility given its control over workforce costs and its low carrying costs. Fixed costs for debt service, pensions, and other post-employment benefits (OPEB) were an affordable 8% of governmental fund spending in fiscal 2015 (net of state support for debt service). Carrying costs also benefit from significant state support for school district pension and OPEB obligations.

In fiscal 2015, the district set aside $3.5 million from the general fund for potential legal costs in a pending federal lawsuit related to a former employee. Management indicates that this amount represents the district's maximum financial exposure in the case.

Long-Term Liability Burden

The district's long-term liability burden for debt and pensions is elevated at 24% of personal income, but is still in the moderate range. The burden is comprised primarily of the district's direct debt, which amortizes slowly. Although the district has no remaining bond authorization, its substantial facility repair and replacement needs will likely necessitate a bond referendum within the next two years. Officials indicate debt capacity of about $70 million below the state's tax rate cap for new issuance. Fitch expects the liability burden to remain within the current range over the medium term.

The district participates in the Teacher Retirement System of Texas (TRS), a cost-sharing multiple employer pension system. The state assumes the majority of TRS's employer contributions and net pension liability on behalf of school districts, except for small amounts which state statute requires districts to assume. Like all Texas school districts, South San Antonio 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 in fiscal 2015. The district's proportionate share of the system's net pension liability is modest at 1.8% of personal income.

Operating Performance

The district historically has maintained very strong financial resilience in its ability to employ spending cuts or draw down operating reserves in the event of a revenue downturn. However, a number of unbudgeted spending items in fiscal 2016--including capital outlay, technology initiatives, and a forensic audit in response to state investigation (now concluded)--produce a projected general fund deficit of $5.3 million, ending the year at about $13 million or 15% of spending. Fitch believes that a lack of spending control in the near term would diminish the district's historically solid gap-closing capacity. The district has adopted a balanced budget for fiscal 2017 and aggressively targets a general fund balance of $18.5 million by 2020.

The Texas Education Agency (TEA) in February 2016 appointed a conservator after the district failed to timely meet the requirements of a state-prescribed corrective action plan for financial management (recurring deficits reduced unrestricted general fund reserves by a cumulative 28% in fiscal years 2009-2012). The conservator has the authority to redirect decisions of the superintendent and board of trustees. The district has met all requirements of the corrective action plan and achieved budget balance on an operational basis. However, the conservator reports continued concerns regarding the district's financial management and general governance. Fitch takes comfort in the state's ability to implement a stronger level of control over district governance if current leadership fails to meet TEA's standards.