OREANDA-NEWS. Fitch Ratings has upgraded the rating on the following Harlandale Independent School District, Texas (the district) unlimited tax (ULT) bonds to 'AA' from 'AA-':

--$121.7 million outstanding ULT and refunding bonds.

In addition, Fitch has upgraded the district's Issuer Default Rating (IDR) to 'AA' from 'AA-'.

SECURITY

The bonds are payable from an unlimited ad valorem tax levied against all taxable property within the district, and are further backed by the Texas Permanent School Fund (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

The upgrade reflects application of Fitch's revised criteria for U. S. state and local governments, which was released on April 18, 2016. The 'AA' IDR reflects the district's strong economic resource base within the City of San Antonio and sound overall financial profile. The district's strong operating profile is a function of considerable expenditure flexibility and expectations for solid revenue growth, yielding a high degree of gap-closing capacity. Stable enrollment performance is expected to require limited capital spending beyond improvements currently underway. As a result, the district's manageable long-term liability burden is expected to remain so in future years.

Economic Resource Base

The district is located within San Antonio, about three miles south of downtown and encompasses 13.7 square miles. The urban area is mostly residential, interspersed with a limited number of commercial establishments. Wealth indicators are well below state and national averages; however, district taxable assessed values (TAV) have shown modest growth in recent years. Enrollment of approximately 15,300 students has increased at a modest pace in recent years, due largely to overall growth in the city.

Revenue Framework: 'a' factor assessment

A combination of local property taxes and state aid supports district operations. The natural pace of revenue growth is expected to remain solid, given historical performance and modestly positive enrollment trends. The district's legal ability to raise revenues is limited, as the current tax rate resides at the legal limit.

Expenditure Framework: 'aa' factor assessment

Spending growth is expected to remain in line with or modestly above that of revenues, given limited capital needs beyond improvements and expansion underway. The district's modest carrying costs reflect a significant amount of state support for debt service and retiree benefits, bolstering spending flexibility.

Long-Term Liability Burden: 'aa' factor assessment

The combined burden of long-term debt and pension liabilities is moderate as a share of total personal income. Fitch expects debt levels to remain manageable, given the district's limited near-term borrowing plans. Retiree benefit obligations do not represent a significant burden.

Operating Performance: 'aaa' factor assessment

The 'aaa' operating performance assessment reflects the district's high reserve funding levels relative to Fitch's expectations of revenue sensitivity, and a considerable level of spending flexibility in the event of revenue declines. Planned draws on fund balance are not expected to materially affect the district's currently healthy financial cushion.

RATING SENSITIVITIES

Maintenance of Financial Flexibility: The rating is sensitive to material changes in the district's currently ample expenditure flexibility and reserve levels, which Fitch expects it to maintain through a typical economic cycle. A reduction in fund balance below currently-planned levels could result in downward rating pressure.

CREDIT PROFILE

The district encompasses a fairly low-income area of the city of San Antonio, and has experienced modest population declines in recent years; however, enrollment has performed positively, with modest steady growth driving solid revenue increases over the last decade.

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 vast 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 79% of district revenues come from state aid, with the remainder generated by property tax revenues. The high level of state support reflects the district's relatively low property wealth levels. Enrollment, which is a key component of state funding, has increased at a consistently modest pace over the last decade, driving solid state aid growth. Expectations for future revenue growth absent policy action are based on anticipated additional enrollment gains, given minimal revenue-raising ability.

District revenues have grown at a compounded annual growth rate of 3.0% over the last decade, performing 0.7% above national CPI, but 0.4% below GDP growth. Fitch expects the natural pace of district revenue growth in future years to perform in line with historical trends.

The district's independent legal ability to raise revenues is limited, as the current maintenance and operations (M&O) tax rate is at the statutory limit of $1.17 per $100 of TAV. The district levies a separate, unlimited debt service tax rate of $0.36, comfortably below the statutory cap of $0.50 per $100 TAV for new debt issuances.

Expenditure Framework

The district spends the vast majority of its operating budget on instruction, and recent initiatives to bolster performance have led to higher instructional and administrative spending in recent years. The district also partially funds capital expenses with current resources.

Fitch expects the natural pace of spending growth over the long term to remain commensurate with revenues absent policy action, given modest enrollment growth and limited near-term capital needs. Planned spending increases over the next several years for operations are not expected to upset this budgetary balance.

The district's high level of expenditure flexibility reflects significant control over workforce costs and very low carrying costs for debt service, pension and other post-employment benefits (OPEB). The carrying costs totaled 4.2% of fiscal 2015 governmental spending and reflected considerable state support for debt service, pension, and OPEB.

Long-Term Liability Burden

The district's long-term liability burden is moderate at 16 % of personal income, and is made up almost entirely by the district's direct debt load. The debt is amortized at a moderate 55.5% of principal repaid in 10 years. The district's near term capital needs are being addressed with past bond proceeds, and limited future borrowing plans suggest that debt levels will likely fall in future years.

The district participates in the Texas Teachers Retirement System (TRS), a cost-sharing multiple employer pension system. Under GASB 67 and 68, TRS' assets covered 83.3% of liabilities as of fiscal 2015, a ratio that falls to 75% using a more conservative 7% return assumption. 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 for certain districts. The proportionate share of the system's net pension liability paid by the district is minimal.

Operating Performance

The district's financial cushion has increased to robust levels despite recessionary pressures and state funding cuts, garnering an 'aaa' assessment. Fitch believes the district would use its solid expenditure flexibility to maintain a satisfactory reserve safety margin in a moderate economic decline scenario.

The district has demonstrated a strong commitment to financial flexibility. Budgeting is conservative and management has been proactive in maintaining operational balance through economic cycles. The district has rebuilt reserves in recent years to a high 38% of fiscal 2015 spending. Fund balance levels were bolstered significantly between fiscals 2010 and 2014, before planned draws for new programming reduced reserves somewhat. The district projects further deficit operations of approximately $5 million in fiscal 2016 on an unaudited basis and has budgeted a draw of $6 million for fiscal 2017. Despite these draws, the district is committed to maintaining reserves at least sufficient to cover two and one half months' operating expenses in future years, or a still-high 21% of spending.