OREANDA-NEWS. Fitch Ratings has assigned an 'AAA' rating based on the Texas Permanent School Fund (PSF) and an 'AA+' underlying rating to the following North East Independent School District, Texas unlimited tax bonds (the bonds or ULTs):

--$35.5 million unlimited tax refunding bonds, series 2016.

The bonds are expected to price via negotiation the week of March 7. Proceeds will be used to refund outstanding obligations for debt service savings without extending final maturity.

In addition, Fitch assigns an 'AA+' underlying rating to the district's outstanding ULTs (pre-refunded basis):

--$241.9 million unlimited tax refunding bonds, series 2007;
--$59.8 million unlimited tax school building, series 2007A;
--$158.3 million unlimited tax school building & refunding bonds, series 2012;
--$65.6 million variable rate unlimited tax school building & refunding bonds series 2013B (conversion to term rate period);
--$$66.1 million variable rate unlimited tax school building bonds, series 2013;
--$56.9 million unlimited tax school building bonds, series 2013;
--$33.2 million unlimited tax refunding bonds, series 2014;
--$110.3 million unlimited tax refunding bonds series 2014A;
--$70.3 million variable rate unlimited tax school building bonds, series 2014;
--$66.8 million unlimited tax refunding bonds series 2014B;
--$354.2 million unlimited tax refunding bonds, series 2015;
--$51.5 million unlimited tax refunding bonds, series 2015A.

The Rating Outlook is Stable.

SECURITY

The bonds are payable from an unlimited property tax levy and are further backed by the PSF bond guaranty program, rated 'AAA' by Fitch. (For more information on the Texas Permanent School Fund see 'Fitch Affirms Texas PSF Rating at 'AAA'; Outlook Stable', dated Aug. 5, 2015).

KEY RATING DRIVERS

SOUND OPERATING PERFORMANCE: North East ISD has maintained reserve adequacy through the recession and state funding cuts. Fitch anticipates the district will maintain structural balance and a healthy financial cushion based on strong expenditure flexibility.

LARGE, DIVERSE AREA ECONOMY: The San Antonio economy is broad and expanding, as evidenced by population and employment growth. Per capita wealth is above state and national averages.

MANAGEABLE LONG-TERM LIABILITIES: Fitch expects the district's debt to remain elevated based on new issuance plans. Moderate carrying costs for annual debt service, pension and other post-employment contributions (OPEB) reflect state support for retiree benefit costs.

RATING SENSITIVITIES

STRONG OPERATING PERFORMANCE: The rating is sensitive to the district's structural balance and sound reserves that mitigate state funding uncertainties.

MANAGEABLE LONG-TERM LIABILITIES: A material increase in long-term liabilities, although not expected, could pressure the current rating.

CREDIT PROFILE

North East ISD is one of the 10 largest school districts in Texas, with a fiscal 2016 enrollment of 67,780. The district serves an urban-suburban population of about 430,000 in north and northeast Bexar County, including portions of San Antonio. Fitch rates both Bexar County and San Antonio general obligation bonds 'AAA', Stable Outlook.

CONSISTENT OPERATING PERFORMANCE; HEALTHY RESERVES

North East ISD has maintained sound reserves throughout the recession and the state funding cuts that occurred in the fiscal 2012 and 2013 biennium. The district manages expenditures within each budget cycle based on available resources and retains adequate expenditure flexibility, primarily through staffing levels. The district's maintenance and operations (M&O) tax rate of $1.04 is at the statutory cap and can only be increased with voter approval; the district reports no immediate plans to approach voters for an increase in the rate.

The district completed fiscal 2015 with a $1 million operating surplus after transfers (.2% of spending) and $112.6 million of unrestricted reserves (22.1% of spending). Fitch anticipates a similar performance in fiscal 2016 based on year-to-date results.

BROAD, RESILIENT SAN ANTONIO ECONOMY

The district's 5.5% average annual tax base growth between fiscal 2012 and 2016 mirrors the greater San Antonio regional economy. Job growth continues to support a favorable county unemployment rate of 3.5% as of December 2015, below the state (4.2%) and U.S. averages (4.8%) for the same period. The district's wealth as measured by personal income per capita trends above state and national averages.
The diverse metro economy features large employers in the insurance, government, health care, telecommunications, grocery, education and the military sectors. The city of San Antonio also benefits from traditionally strong tourism and trade. IHS projects robust medium term growth for the city, driven by professional/business services, education, health services, and construction/mining.

MANAGEABLE LONG-TERM LIABILITIES

North East ISD received a strong 66% of voter support for its 2015 bond program, the fourth consecutive successful bond election in 12 years. The district plans to issue its remaining $500 million of authorization over the next three years, primarily for campus renovations. Management reports the district is more than 90% built out, lessening future facility and borrowing needs. Correspondingly, enrollment growth has slowed and officials anticipate modest annual increases of less than 1% going forward.

Fitch anticipates the district's debt burden (6.5% of fiscal 2015 market value) to remain elevated over the near term considering current debt plans and an average principal amortization rate. The district plans to keep its fiscal 2016 interest and sinking fund (I&S) tax rate ($0.375 per $100 of taxable assessed value [TAV]) flat for the next five years. This projection assumes annual tax base growth of between 2% and 4%, less than recent growth realized by the district. The I&S tax rate is comfortably below the $0.50 statutory rate cap for new debt issuance.

The district's debt service burden consumed 13.2% of fiscal 2015 governmental expenditures. The district historically maintains a moderate amount of its debt portfolio in variable-rate unlimited tax bonds, currently estimated at about 15% of the total debt outstanding, well within the district's policy ceiling of 25%.

Terms of the district's three variable-rate bond series include one-to-five-year fixed-rate terms, a soft put to bondholders in lieu of liquidity support, and the option to reset the rate to a long-term fixed basis until final maturity. Fitch considers the risks associated with a failed remarketing (which would result in an elevated interest rate of up to 7%) manageable, based on assumed ready market access given the district's sound credit profile.

LIMITED PENSION/OPEB OBLIGATIONS

The district participates in the Texas Teachers Retirement System (TRS), a cost-sharing multiple employer pension system. Under GASB 67 and 68, TRS's assets cover 83.3% of liabilities as of fiscal 2015, a ratio that falls to a Fitch-estimated 75% using a more conservative 7% return assumption. Contributions are determined by state statute, rather than actuarially, and historically have fallen short of the actuarial level. Recent reforms have lowered benefits and increased statutory contributions to improve plan sustainability over time.

The state assumes the majority of TRS' 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, the district 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 year 2015.

The district's proportionate share of the system's net pension liability is minimal, representing less than 0.5% of fiscal 2015 market value. The district's contributions currently are limited to 1.5% of salaries and the pension costs for salaries above the statutory maximum (total contribution of $12 million in fiscal 2015). Carrying costs for debt service, pensions and OPEB were moderate at 15% of fiscal year 2015 governmental spending.

TEXAS SCHOOL DISTRICT LITIGATION

A Texas district judge ruled in August 2014 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 and was the second such ruling in the past two years, found the system inefficient, inequitable, and underfunded. The judge also ruled that local school property taxes are effectively a statewide property tax due to lack of local discretion and therefore are unconstitutional.

The Texas attorney general has appealed the judge's latest ruling to the state supreme court. If the state school finance system is ultimately found unconstitutional, the legislature would likely follow with changes intended to restore its constitutionality. Fitch would consider any changes that include additional funding for schools and more local discretion over tax rates to be a credit positive.