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

--$8.9 million ULT refunding bonds, series 2016.

The 'AAA' rating is based on the guarantee provided by the Texas Permanent School Fund (PSF), whose bond guarantee program is rated 'AAA' by Fitch. For additional information on the Texas PSF rating please see Fitch's Aug. 5, 2015 press release, 'Fitch Affirms Texas Permanent School Fund at 'AAA'; Outlook Stable', available at 'www.fitchratings.com'.

The bonds are scheduled for sale January 25 via negotiation. Proceeds will be used to refund a portion of the district's outstanding ULT debt for interest savings.

Fitch also assigns an 'AA-' underlying rating to the series 2016 bonds and affirms its 'AA-' rating on the district's $40.7 million in outstanding ULT bonds, series 2008 and 2015.

The Rating Outlook is Stable.

SECURITY

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

KEY RATING DRIVERS

SOUND FINANCIAL PROFILE: The district has successfully weathered a series of financial challenges, including a bankruptcy filing by the district's largest taxpayer and state funding cuts. Reserves are healthy, the result primarily of prompt spending reductions in response to these challenges. Restoration of state funding cuts and renewed tax base growth have eased operating pressures.

CONCENTRATED LOCAL ECONOMY: Petrochemical tax base concentration exposes the district to economic cyclicality, which is somewhat mitigated by the stability of an area-wide employment base anchored by military, education, government and health services. Ongoing oil industry weakness may reverse some recent economic gains generated by activity associated with the Eagle Ford shale exploration activity in south Texas. Unemployment is low, with above-average measures of income and wealth.

DEBT AND BENEFIT LIABILITY MANAGEABLE: Overall debt levels are moderate. The district's low carrying costs reflect slow amortization of direct debt and state funding for all but a small portion of pension and other post-employment benefit (OPEB) obligations.

LIMITED CAPITAL NEEDS: Management has identified a need for additional elementary classroom capacity, but recent economic uncertainty likely will delay any decision on new campus construction.

RATING SENSITIVITIES

LOSS OF FINANCIAL FLEXIBILITY: A material decline in the district's operating reserves likely would pressure the current rating. Conversely, continued strengthening of financial flexibility could lead to positive rating action.

CREDIT PROFILE

Calallen ISD is a small, 30 square mile district (enrollment roughly 4,000) located within the northwestern portion of Corpus Christi, the eighth largest city in Texas, whose general obligation bonds are rated 'AA' by Fitch, with a Stable Outlook.

PETROCHEMICAL CONCENTRATION; OIL INDUSTRY VOLATILITY

The district includes a small portion of Corpus Christi, an industrial and commercial center in south-central Texas dominated by the petrochemical industry and boasting the sixth largest deepwater port in the nation as measured by tonnage. The regional economy has benefited the past several years from the explosive growth in oil exploration in the Eagle Ford Shale in south Texas. Much of the processing and shipment of Eagle Ford oil occurs in Corpus Christi, and area industries, including refining operations, have expanded over the past year. The recent sharp drop in oil prices will negatively affect the pace of drilling in south Texas and will likely slow economic growth in the Corpus Christi area. District management reports it will monitor the impact of any economic slowdown on enrollment and future classroom capacity needs.

Calallen ISD's tax base is concentrated with the top 10 taxpayers accounting for 26% of fiscal 2016 taxable assessed valuation (TAV), and the largest taxpayer, Equistar Chemicals LP, representing a significant 13%. Equistar, which filed for bankruptcy protection and negotiated an appraisal reduction, is now currently expanding operations, and the additions are expected to add several hundred million dollars to the district's tax base when completed in fiscal 2017. District TAV resumed growth in fiscal 2013, following recessionary declines and the impact of the Equistar bankruptcy, and has grown more than 34% over the past three years to $1.5 billion for fiscal 2016.

Area employment is diverse and the unemployment rate tends to trend below the national rate. Largest employers include the Corpus Christi Army Depot, Corpus Christi ISD, CHRISTUS Spohn Health Systems, H.E.B. Grocery, the City of Corpus Christi and Corpus Christi Naval Air Station. Corpus Christi income measures are typically comparable to state and U.S. averages.

SOUND FINANCIAL PROFILE

The district added to general fund reserves each of the past six fiscal years despite TAV declines, net state-funding reductions of nearly $2 million (approximately 10% of annual state operational funding), and low enrollment growth. A restoration of state funding for fiscals 2014 and 2015, paired with TAV growth, facilitated a restoration of spending cuts implemented during the previous biennium (salary reductions and freeze, reduced work days, eliminated positions). Fiscal 2015 operations resulted in a $1.7 million boost to general fund reserves, increasing the unrestricted fund balance to $9.5 million or 29% of spending and transfers out.

The fiscal 2016 budget is operationally balanced despite flat enrollment expectations and a 2% pay hike. The district is currently constructing an emergency safety dome at the cost of $5.3 million. However, management anticipates a federal government reimbursement for a portion of the project, resulting in a modest general fund drawdown of about $400,000. Fall enrollment for fiscal 2016 was up only modestly (35 students or less than 1%) from previous year, continuing a trend of minimal enrollment growth over the past decade.

TAX RATE SWAP

The district's maintenance & operation (M&O) tax rate increased to the maximum rate of $1.17 per $100 of TAV in fiscal 2011 following a voter-approved transfer of $0.125 from the debt service fund. The tax rate swap provides the district with approximately $700,000 in additional state aid for operations, which flows to the general fund balance each fiscal year for subsequent transfer to the debt service fund. Fitch views the tax rate structure as unconventional, but notes a number of Texas school districts have instituted similar swaps and also recognizes the debt service tax rate could be raised without voter authorization to repay outstanding debt or reversed if needed.

MANAGEABLE DEBT

Overall debt levels are moderate at $3,903 per capita and 4.9% of market value. Amortization is slow with less than 40% of debt retiring in 10 years. Management indicates a likely need for additional elementary classroom capacity in the next two years, but the current weakness in the oil and gas industry may delay a decision until any enrollment impact can be discerned. The district's fiscal 2016 debt service tax rate is relatively low at $0.206 per $100 of TAV; the low rate provides ample capacity for additional debt if necessary as it is well below the statutory cap of $0.50 for new debt issuance.

The district's pension and OPEB liabilities are limited to its participation in the state pension plan administered by the Teachers Retirement System of Texas (TRS), a cost-sharing multiple employer plan for which the state funds the majority of employer contributions. The district's cost for pension and OPEB represented less than 2% of governmental fund expenditures in fiscal 2015, and the district consistently funds its contractually required contribution.

The state's funding of school districts' payments to TRS helps keep fixed costs low. However, like all Texas school districts, Calallen ISD is vulnerable to future funding changes by the state, as evidenced by a relatively modest 1.5% of salary contribution requirement effective 2015. The district's carrying costs (combined debt, pension and OPEB payments) were low at 9.6% of governmental fund spending for fiscal 2015, although that amount will likely climb with the additional district pension contributions.

TEXAS SCHOOL FUNDING LITIGATION

A 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 will 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.

Additional information is available at 'www.fitchratings.com'.

Fitch recently published an exposure draft of state and local government tax-supported criteria (Exposure Draft: U.S. Tax-Supported Rating Criteria, dated Sept. 10, 2015). The draft includes a number of proposed revisions to existing criteria. If applied in the proposed form, Fitch estimates the revised criteria would result in changes to less than 10% of existing tax-supported ratings. Fitch expects that final criteria will be approved and published by the end of the first quarter of 2016. Once approved, the criteria will be applied immediately to any new issue and surveillance rating review. Fitch anticipates the criteria to be applied to all ratings that fall under the criteria within a 12-month period from the final approval date.

In addition to the sources of information identified in Fitch's 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, Municipal Advisory Council of Texas, and National Association of Realtors.

Applicable Criteria

Exposure Draft: U.S. Tax-Supported Rating Criteria (pub. 10 Sep 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869942

Tax-Supported Rating Criteria (pub. 14 Aug 2012)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

U.S. Local Government Tax-Supported Rating Criteria (pub. 14 Aug 2012)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=997968

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=997968

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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