Fitch Rates Hidalgo ISD, TX's ULT Rfdg Bonds 'AAA' PSF/'A-' Underlying; Outlook Negative

Fitch Ratings has assigned an 'AAA' rating to the following Hidalgo Independent School District, Texas' (Hidalgo ISD, or the district) unlimited tax (ULT) bonds:

--$7.5 million in ULT refunding bonds, series 2012;

The 'AAA' long-term rating on the bonds is based on a guaranty provided by the Texas Permanent School Fund (PSF), whose bond guaranty program is rated 'AAA' with a Stable outlook by Fitch.

The bonds are scheduled for negotiated sale as early as the week of May 28. Proceeds will be used to refund certain outstanding bonds of the district for interest cost savings.

Fitch also assigns an 'A-' underlying rating to the bonds and affirms the 'A-' on the district's $44.3 million in outstanding ULT bonds (pre-refunding).

The Rating Outlook on the underlying rating remains Negative.

SECURITY
The bonds are secured by an unlimited ad valorem tax pledge levied against all taxable property within the district. The bonds are further secured by a guaranty from the Texas Permanent School Fund (PSF), whose bond guaranty program is rated 'AAA' by Fitch.

KEY RATING DRIVERS

SOME STABILIZATION OF FINANCES: The new management team has gained traction in restoring the district's financial position, which sharply deteriorated after prior mismanagement and accounting misstatements resulted in the improper use of capital funds and a negative general fund balance position. Audited fiscal 2011 results show an operating surplus, improvement in the general fund balance, and reduction of the liability to the capital projects fund.

ONGOING BUDGETARY PRESSURE: Despite the initial progress, the Negative Outlook reflects Fitch's concerns over the continued financial pressure on the district applied by state budget cuts, lower attendance-based state aid, and remaining liability to the capital projects fund. Operating reserves and liquidity remain low.

MANAGEABLE DEBT BURDEN: Overall debt levels are slightly above average after adjusting for direct state support for debt service. The annual debt service cost on the budget is low, amortization is average, and capital needs are minimal.

LIMITED ECONOMY & TAX BASE: The district's economic base, part of the larger Rio Grande Valley economy, remains challenged and socioeconomic indicators are subpar. Taxable assessed valuation (TAV) has shown some year-to-year volatility and is down a modest 2.5% from the peak TAV in fiscal 2009.

WHAT COULD TRIGGER A RATING ACTION

EXTENT OF FINANCIAL IMPROVEMENT: Departure from the district's stated financial recovery plan likely would apply downward pressure on the rating. Alternatively, continued improvement in the general fund's position and further progress towards repayment of the capital projects fund liability would be viewed favorably in terms of the Rating Outlook.

CREDIT PROFILE

PRIOR MISMANAGEMENT PROMPTED USE OF BOND PROCEEDS FOR CASHFLOW
Hidalgo ISD's financial flexibility through fiscal 2008 was largely overstated due to mismanagement by the prior staff. The restatement of the beginning fiscal 2009 position -- adjusted downward for a significant delayed payroll expenditure and unverifiable receivables -- eliminated most of the district's reported general fund balance. District officials subsequently used $3.5 million of series 2008 tax-exempt bond proceeds for general fund cashflow while incurring a $2.8 million operating deficit (7% of spending); the net effect at fiscal year-end 2009 was a negative $1.5 million unreserved general fund balance and $3.5 million payable to the capital projects fund.

In May 2010, the district's new finance staff submitted a financial recovery plan to the state education agency, which outlined steps the district would take to restore balanced operations, replenish reserves, and repay the liability to the capital projects fund. The district also issued $4.5 million in 10-year cash flow notes, which enabled fiscal 2010 audited results to show a positive unreserved general fund balance equal to 2% of spending; absent the cash flow notes, results would have shown another deficit.

FISCAL 2011 RESULTS SHOW IMPROVEMENT IN LINE WITH FINANCIAL RECOVERY PLAN
As part of the recovery plan, voters approved a 13 cent (12.5%) increase in the fiscal 2011 operating tax rate to the statutory maximum of $1.17 per $100 TAV, and management reduced spending by 7% through layoffs and attrition. The resultant surplus enabled $1 million in payments to be made the capital projects fund -- reducing the liability from $3.5 million to $2.5 million -- while boosting the year-end fiscal 2011 unrestricted general fund balance (the sum of committed, assigned, and unassigned per GASB 54) to $1.6 million or 5% of spending.

PROGRESS CONTINUING IN FISCAL 2012 DESPITE BUDGET PRESSURE ON SEVERAL FRONTS
The original recovery plan was revised by management in 2011 to accelerate the repayment of capital funds by 2013 rather than 2015. As planned, the district also absorbed a $1.2 million reduction (5%) in state formula-funding due to state budget cuts with layoffs, attrition, and discretionary spending cuts, but after adopting the budget, officials were forced to carve out an additional $1.3 million in savings to offset below-budget attendance. Officials note that previously low class-size ratios have enabled the bulk of savings to come from attrition, and staffing reports show a 6.5% reduction in total personnel in the past two years.

Despite the pressures, the district made scheduled payments to the capital projects fund of $950,000 in early fiscal 2012 and Fitch has confirmation of an additional $610,000 payment in March 2012, which is notably ahead of schedule and was aided by enhanced cashflow from a delayed state aid payment and a mid-year rebound in attendance-based revenues.

With continuing cost savings and tightened budget controls, management presently expects to achieve a $490,000 operating surplus (1.6%) by year-end and the 2012 audit to show a lower capital projects fund liability of $950,000. Management presently plans to budget for the full liability amount in fiscal 2013 but may defer half of the payment to 2014, under guidance from bond counsel, to provide staff raises.

While Fitch notes the positive headway the district has made in recovery, the tight state funding environment, remaining liability to the capital projects fund, and still low operating reserves and liquidity remain of concern and warrant maintenance of the Negative Outlook. Fitch views continued, timely progress in eliminating the capital projects fund liability as key to credit quality.

LIMITED ECONOMY & TAX BASE
Hidalgo ISD is a small district located in the southern-most region of Texas on the Mexico border. The district encompasses 36 square miles and the city of Hidalgo. In contrast to previous forecasts, district enrollment fell for the second consecutive year by 5% to 3,255 due mainly to competition from a neighboring district and a nearby charter school system. Officials believe the bulk of enrollment losses have already occurred and flat to modest declines are expected over the next few years.
The district's fiscal 2012 TAV of $408 million remains about 2.5% below the 2009 peak, but Fitch considers this cumulative loss in taxable value modest. Top taxpayer concentration is a credit concern and slightly worsened in 2012; the top 10 payers comprise a high 23.5% of fiscal 2012 TAV, which is up from 21% in 2011.

Area socioeconomic indicators, available at the county level, are subpar with low wealth levels and a typically high unemployment rate. However, the March 2012 unemployment rate improved to 10.7% from 12.0% year-over-year as employment gains outpaced labor force gains.

MANAGEABLE DEBT LOAD
Overall debt levels are slightly above average at 5.5% of market value and $4,392 per capita. Due to its low wealth levels, the district benefits from substantial state support at about 64% of annual debt service. Net of the debt service aid, the annual debt service cost on the budget is affordable at 7% of fiscal 2011 spending. Amortization is about average at 56% of principal retired in 10 years.

Pension and other-post employment benefit (OPEB) liabilities are limited to the district's participation in the Teacher Retirement System of Texas (TRS), a cost-sharing multiple employer plan. Combined pension and OPEB spending consumed less than 1.5% of fiscal 2011 spending, and the district consistently funds its annual required contribution.

Additional information is available at www.fitchratings.com. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

In addition to the sources of information identified in the 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, Zillow.com, National Association of Realtors, and Texas Municipal Advisory Council.

Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria', dated Aug. 15, 2011.
--'U.S. Local Government Tax-Supported Rating Criteria', dated Aug. 15, 2011.

Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648898
U.S. Local Government Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648842

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