Jan 11 - Fitch Ratings takes the following action on Weslaco Independent School District, Texas' (ISD, or the district) unlimited tax (ULT) bonds: --$68.4 million ULT bonds series 2005, 2006, and 2008 affirmed at 'AA-'. The Rating Outlook is Stable. SECURITY: The bonds are secured by an unlimited ad valorem tax pledge of the district as well as a guaranty from the Texas Permanent School Fund. KEY RATING DRIVERS: SATISFACTORY FISCAL CUSHION: The district retains a satisfactory level of operating reserves and liquidity despite state budget cuts. Additional flexibility is evidenced by the district's significant general fund transfers for capital outlays. STABLE RESOURCE BASE: The district is part of the broad and growing Rio Grande Valley economy and continues to register modest taxable assessed valuation (TAV) gains; the area housing market has remained fairly stable. BELOW-AVERAGE SOCIO-ECONOMIC PROFILE: Income levels and tax base wealth are low while unemployment and poverty rates are elevated. AFFORDABLE DEBT BURDEN: Debt ratios are mixed but the fixed-cost burden for long-term liabilities is affordable as a result of significant state subsidies. WHAT COULD TRIGGER A RATING ACTION: LOSS OF FINANCIAL FLEXIBILITY: Deterioration in financial flexibility would be a negative credit consideration given the importance of the currently sound reserves as an offset to the below-average economic metrics. CREDIT PROFILE: Weslaco ISD is in Hidalgo County near the Texas-Mexico border, midway between the cities of McAllen (rated 'AA+ with Stable Outlook by Fitch) and Harlingen (rated 'AA-' with Stable Outlook). The city of Weslaco is the district's major commercial center and had a 2010 population of 35,670. ADEQUATE FISCAL CUSHION The district's meaningful level of financial flexibility is the key credit characteristic supporting the rating and an important offset to the below-average economy. The district has maintained an available general fund balance at 10%-14% of spending in the past five fiscal years while making significant general fund contributions for capital projects. A $9.8 million operating transfer (7% of spending) was made in fiscal 2011 to build a new band hall and athletic facility and make other improvements following voter rejection of a bond proposition in May 2010. Despite the large transfer out, the unrestricted general fund balance declined modestly by $1.1 million to $19 million or a sound 13.7% of spending. TAX RATE RESTRUCTURING IN FISCAL 2012 Weslaco ISD voters in fiscal 2012 approved a tax rate restructuring that maintained the $1.14 total tax rate while shifting the entire debt service tax rate to the general fund. The net effect was to generate additional total revenues (roughly $1 million annually) under provisions in the state's funding formula that more heavily reward general fund taxing effort. Annual ULT debt service of $6.3 million is now repaid via annual transfers from the general fund. Fitch recognizes the slight revenue advantage to the district but notes this unconventional taxing structure could be subject to legislative or statutory changes. However, credit concerns are mitigated by the district's retained unlimited taxing power for debt service that does not require voter approval, management's ability to reverse the tax rates if necessary, and a sound liquidity position with cash and investments in the general fund totaling 4.9x current liabilities. PRIOR-PERIOD ADJUSTMENT ADDS TO 2012 OPERATING RESERVES The additional revenue from the new tax rate structure was used to partly offset the first year of cuts in the state's fiscal 2012-13 biennial budget, from which the district lost $5.7 million (4%) in fiscal 2012 revenue. Management offset the shortfall by using all of the $3.6 million debt service fund balance (as planned under the tax rate restructuring), $1.1 million in one-time federal aid, and reducing capital expenditures. The district concluded fiscal 2012 with a $2.3 million general fund operating surplus after transfers. A significant $4.6 million prior-period adjustment for revenues owed to the district by the state in fiscal years 2010 and 2011 but not received further boosted the fiscal 2012 unrestricted fund balance to $23.6 million or 16% of spending. MAINTENANCE OF SOLID RESERVES CRITICAL TO RATING STABILITY The fiscal 2013 $146.7 million operating and debt service budget is balanced despite additional modest revenue pressure from state cuts and loss of one-time funds. A $2 million possible general fund liability to an internal service fund was discovered in a special audit by the state after adoption of the budget. The district has budgeted repayment in fiscal 2013 from unrestricted fund balance, and management may appropriate additional reserves that are in excess of the district's informal $15 million fund balance target (roughly 10% of the fiscal 2013 operating budget) for capital outlays. Fitch notes that while the planned fund balance draw-downs are non-recurring in nature, the maintenance of a fiscal cushion in line with the policy minimum is critical to rating stability. LIMITED LOCAL ECONOMY PART OF BROADER MCALLEN MSA The district is part of the growing McAllen-Edinburg-Mission statistical area that is located just seven miles north of the Mexican border and the city of Reynosa, Tamaulipas. Agribusiness is a major economic component of the region as is international trade given the proximity to Mexico, especially the maquiladora program where manufacturing and assembly occurs in plants located in Reynosa and warehouse and distribution is handled in the U.S. In addition, the stable government, education, and health service sectors make up a combined 50% of the MSA's non-farm labor force; top employers in the city of Weslaco include the school district and a local hospital. Unemployment in the county is elevated relative to the state and nation, a trend that is common in communities with a significant agriculture labor force, although the area notably added jobs during and after the economic downturn. The most recent unemployment rate dropped to 10.3% from 12.2% for the year-ending October 2012 due to a decline in labor force participation. District wealth and income levels are well below average but this concern is tempered by the area's low cost-of-living and still good tax affordability. MODEST AV AND ENROLLMENT GROWTH The mostly residential tax base continues to appreciate in value due to positive re-appraisal and modest resident and commercial development occurring, although the rate of TAV growth is much lower than before the national recession. Fiscal 2013 TAV climbed 1.3% to $1.86 billion, and continued stability in the tax base is likely based on Fitch's review of economic data. Enrollment growth has also tapered off due to competition from a nearby charter school system; year-to-date attendance in 2013 is up marginally by 0.7%. Management expects modest enrollment gains to continue, a projection Fitch views as reasonable for budgeting purposes. LONG-TERM LIABILITIES REMAIN AFFORDABLE The district is heavily funded by the state, but the aid that was previously restricted for debt service now flows to the district as discretionary funding (as a result of the tax rate change). Fitch no longer considers this to be self-supporting debt. With this change, overall debt levels rise to an above-average 5.5% of market value (from 3.2%) but still low $1,950 per capita. The pace of amortization is average at 55% retired in 10 years and the carrying cost remains low. The district has no remaining ULT debt authorization but may issue $3 million of limited tax notes in the next few years to fund HVAC improvements and bus purchases. The district fully funds it's statutorily required contributions for pension and other post-employment benefits (OPEB). Both benefit plans are provided through the Teacher Retirement System of Texas (TRS), a cost-sharing multiple employer plan. TRS remains well funded at 74.5% using Fitch's more conservative 7% investment rate of return assumption. Audited debt, pension, and OPEB contributions consumed an affordable 6.1% of fiscal 2012 general fund and debt expenditures.