Albuquerque Muni. SD 12 (Bernalillo Cnty), NM

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1 CREDIT OPINION New Issue Albuquerque Muni. SD 12 (Bernalillo Cnty), NM New Issue: Moody's Assigns Aa1 to Albuquerque MSD 12, NM's $115M GO Debt; Negative Outlook Summary Rating Rationale Contacts Heather Correia Associate Analyst John Nichols AVP - Analyst john.nichols@moodys.com Moody's Investors Service has assigned a Aa1 to Albuquerque Municipal School District 12 (Bernalillo County), NM's $100 million in General Obligation School Building Bonds, Series 2017 and $15 million in General Obligation Education Technology Notes, Series Concurrently, we have affirmed the Aa1 on $508.6 million in outstanding parity obligations. The outlook remains negative. Moody's has also assigned a Aa2 enhanced rating to the General Obligation School Building Bonds, Series 2017 based on the New Mexico School District Enhancement Program (NMSDEP) - Post March 30, The Education Technology Notes do not qualify for the State's enhancement program. The Aa1 rating reflects the district s sizeable tax base that serves as the state s largest economic center; stable, albeit narrow, financial position with a sizeable surplus reported in fiscal 2016, which will likely be offset with state cuts in fiscal 2017; and, manageable debt profile with average principal payout. The rating further incorporates the district s elevated pension burden and declining enrollment, reflective of reduced birth rates and charter school competition. The Aa2 enhanced rating on the Series 2017 General Obligation School Building Bonds is based on our assessment of the NMSDEP - Post March 30, 2007 and a review of the district's proposed financing. For additional information on the program, please see Moody's report dated May 4, Credit Strengths District serves a regionally-important economy; consistent tax base expansion Manageable debt profile with above average principal amortization Credit Challenges Historically narrow financial reserves; further cuts in state funding possible for fiscal 2017 and fiscal 2018 Modest declines in enrollment; charter school competition Elevated pension liability

2 Rating Outlook The negative outlook reflects the district s narrow financial position, which may be compromised with continued funding declines from the State. Sustained use of reserves may warrant downward rating action. Factors that Could Lead to an Upgrade (or removal of the negative outlook) Significant increase in reserves to levels adding financial flexibility Noteworthy tax base expansion and diversification coupled with improved socioeconomic profile Factors that Could Lead to a Downgrade Structural imbalance resulting in deterioration of reserve levels Significant contraction of the tax base Enrollment loss without corresponding expenditure management Key Indicators Exhibit 1 Source: District's Audits; Moody's Investors Service Recent Developments In February 2016, voters approved a $200 million bond and a $375 million HB33 levy. Shortly thereafter, a citizen filed a motion to invalidate the election results. With pending litigation, Bond Council could not sign off on the bonds for issuance. After nine months of litigation, the State's Supreme Court ruled the election valid. The issue is resolved, and management reports that this legal dispute did not impede ongoing capital projects. Detailed Rating Considerations - Enhanced Moody's has assigned an enhanced rating of Aa2 to the Series 2017 General Obligation School Building Bonds, equivalent to the NMSEP Post-March 30, 2007 programmatic rating. Ratings on individual intercept financings depend on the programmatic rating as well as our evaluation of the sufficiency of interceptable revenues, the timing of the state's fiscal year relative to scheduled debt service payment dates and the transaction structure. This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on for the most updated credit rating action information and rating history. 2

3 Based on the district's state equalization guarantee (SEG) funds for fiscal year 2016 (unaudited), interceptable state-aid provides an ample minimum of 8.56 times coverage of maximum periodic debt service. Further, state revenues provide an adequate minimum 7.85 times maximum periodic debt service coverage when coverage is stressed by deducting the state's final monthly state aid payment within a fiscal year. State-aid funding levels for New Mexico school districts have been stable in recent years, but have been subject to midyear cuts, as observed most recently in fiscal This weakness, however, is mitigated by ample debt service coverage even if aid is curtailed over the course of the year. Principal payments are scheduled for August, early in the State's fiscal year providing for an average interval to mitigate the risk of late budgets. The program requires the appointment of a third-party fiscal agent, who is required to notify the state if an intercept of SEG is required. The Bank of Albuquerque is the fiscal agent for the current sale. Detailed Rating Considerations - Underlying Economy and Tax Base: District Serves Economic Engine of New Mexico The district's tax base will likely continue to modestly expand over the mid-term driven by appreciation of existing properties and steady development across all sectors. Albuquerque, and by extension, the district's, economy is anchored by the University of New Mexico (UNM) flagship campus and a number of defense-related operations, such as Kirtland Air Force Base and Sandia National Labs. The tax base is sizeable, with the fiscal 2017 assessed value (AV) expanding by 3.1% to $15.8 billion, derived from a full value of $47.6 billion. Residential development remains steady, with the number of new listings increasing by 8.5% from September 2015 to September Additionally, retail and commercial development is ongoing, with new restaurants, national clothing stores and medical practices either coming online or expanding. Over the near-term, officials anticipate annual AV growth of 2% to 3%. Wealth indices are average, with median family income reported at 94% of US (2013 American Community Survey). Concentration in top ten taxpayers is negligible at 2.7% of fiscal 2017 AV. County unemployment levels are slightly elevated at 5.9% compared to the nation's 4.8% as of September Albuquerque Public Schools (APS) is the 34th largest district in the nation. District enrollment has declined in the past five years, falling from 89,602 in fiscal 2013 to 84,685 in fiscal During the same timeframe, charter school enrollment has climbed from 12,527 to 16,845. To mitigate charter school competition, APS has invested in schools of choice, which offer courses in STEM and project-based learning; rolled out several pre-k offerings; and partnered with UNM and Central New Mexico Community College to offer college credit. The district's efforts have proved successful, at least in fiscal 2017, with 85,905 enrolled in traditional district schools and 14,656 enrolled in charter schools. Moving forward, barring presence of charter schools, APS is anticipating annual enrollment declines through fiscal Officials explain that birth rates typically determine class sizes; the region's birth rates were down in 2012 through 2015, with an uptick in As such, management expects a low of 84,533 before increasing to 85,000 by fiscal Future reviews will focus on the district's ability to attract and retain students, and to manage fluctuations in enrollment without utilizing reserves. Financial Operations and Reserves: Narrow Financial Position; Surplus in Fiscal 2016 Expected to Offset Cuts in Fiscal 2017 The district is in a position to manage current-year state aid funding reductions; however, continued use of reserves to weather the state's cuts will likely pressure the rating. APS ended fiscal 2015 with a sizeable surplus of $7 million, increasing General Fund balance to $50 million, or 7.7% of revenues. Since fiscal 2010, the district has reported consistent surpluses, increasing General Fund balance by $26.6 million in aggregate. Similarly, Operating Fund Balance, including the General Fund and Debt Service Fund, has increased $48.3 million in the same time frame to a fiscal 2015 balance of $123.4 million, or 17.2% of operating revenues. While these trends are positive, the district's reserve position remains very narrow compared to Aa1-peers. Fiscal 2016 unaudited results indicate another $8.8 million surplus, increasing the General Fund balance to $58.8 million, or 8.7% of revenues. The district benefitted from vacancy savings and reduced healthcare and utility costs. When preparing the fiscal 2017 budget, officials anticipated a mid-year cut in state aid, and set aside $7.6 million to mitigate any funding declines. The Legislature, in a Special Session, voted to cut state aid (SEG) by 1.5% and reduce categorical funding by $17.5 million. Specific to APS, this translates to a total reduction of $13.1 million ($9.5 million in SEG, $3.6 million in categorical). This loss will be partially offset by the district's set aside, as well as $2.1 million in categorical fund balance that was previously restricted. The remaining $3.4 million will either be absorbed with fund balance or through budgetary-savings. APS is anticipating fiscal 2017 to end with a $8 million deficit, reducing General Fund balance to $50.8 million, or 7.2% of budgeted revenues. If the district were to absorb an additional $3.4 million, General Fund balance would decline to $47.8 million, or 6.8% of budgeted revenues. APS is in a position to utilize fund balance in fiscal 2017 due to a focused build-up of reserves over the past several years. However, going forward, it would be considered a credit weakness 3

4 if management continues to use reserves to balance the budget rather than make expenditure adjustments as it would reduce the already narrow financial flexibility. The Legislature meets again in early The State has indicated they are willing to consider further cuts and/or a fund balance sweep. While APS has always operated within a narrow margin, this practice offers the district very little financial flexibility, especially in the case of unexpected, mid-year funding adjustments. If the State were to implement additional cuts in fiscal 2017 or materially reduce SEG in fiscal 2018, APS' will be challenged to manage these reductions without compromising its already-limited reserve position. LIQUIDITY The district's General Fund cash position improved in fiscal 2015 to $93.1 million, or 14.3% of revenues, compared to prior year's $70.4 million, or 11.2% of revenues. Operating cash reserves, including the General Fund and Debt Service Fund, was $165.8 million, or 22.9% of operating revenues. Fiscal 2016 unaudited results indicate General Fund cash remained stable at $94.2 million, or 13.9% of unaudited revenues. Debt and Pensions: After Legal Battle, APS Issues Series 2017 Bonds; Debt Burden Manageable; Pension Burden is Very Elevated In February 2016, voters approved a $200 million bond and a $375 million HB33 levy. Shortly thereafter, a citizen filed a motion to invalidate the election results. With pending litigation, Bond Council could not sign off on the bonds for issuance. A district court ruled the election valid, but the citizen appealed to the New Mexico Supreme Court. In November 2016, the Court ruled in a 5-0 decision that both the bond and mill levy elections were valid, thereby allowing the district to move forward with their capital plans. Management reports that this legal dispute did not impede ongoing capital projects. Of the $100 million being issued, $25 million is from the 2013 authorization (final issuance) and $75 million is from the 2016 authorization. Post-sale, the district will have another $125 million in authorized bonds, which they plan to issue in The debt burden is manageable at 1.3% of fiscal 2017 full value, which is in line with national peers. Included in the $623.6 million in outstanding obligations are $25 million in Education Technology Notes. Both the bonds and notes are secured by an unlimited ad valorem pledge. Despite plans for additional debt, the district's debt burden is expected to remain manageable given assessed value growth assumptions and good principal amortization. DEBT STRUCTURE All the district's debt is fixed rate, and is fully amortized by fiscal Principal amortization is average with 75.7% retired in ten years. DEBT-RELATED DERIVATIVES The district has no derivatives, swaps or variable-rate debt. PENSIONS AND OPEB The district has an above-average employee pension burden, based on unfunded liabilities for its share of the Educational Retirement Board (ERB), a cost sharing plan administered by the state. Moody's fiscal 2015 adjusted net pension liability (ANPL) for the district, under our methodology for adjusting reported pension data, is $2.5 billion, or an elevated 3.45 times operating revenues. The threeyear average of the district's ANPL to operating revenues is 3.29 times, while the three-year average of ANPL to full value is high at 5.21%. The district's ANPL has fluctuated over the last several years. In fiscal 2015, pension contributions of $71.2 million were below Moody s tread water value of $89.1 million, a credit negative. The tread water indicator measures the annual contributions required to prevent the reported net pension liability from increasing, under reported assumptions. The district s fixed costs, including debt service, pensions contributions and OPEB contributions, totaled a somewhat elevated 22.4% of operating revenues, further limiting the district's financial flexibility. The New Mexico pension plan funding structure experienced several changes with the signing of SB 115, including the reduction of a cost-of-living adjustment (COLA) and increases in employee contributions. The legislation will maintain the funding changes until the plan has reached 100% funding, which is estimated to be achieved in We believe the funding changes adopted in SB 115 will limit budgetary pressure on the district related to future pension costs. 4

5 Moody's ANPL reflects certain adjustments we make to improve comparability of reported pension liabilities. The adjustments are not intended to replace the district s reported liability information, but to improve comparability with other rated entities. For more information on Moody's insights on employee pensions and the related credit impact on companies, government, and other entities across the globe, please visit Moody's on Pensions at Management and Governance New Mexico school districts have an institutional framework score of A, or moderate. Districts have a low ability to raise revenues because state aid provides over 90% of funding, and property taxes are subject to a small 0.5 mill cap. State aid is moderately predictable given a recent trend of increased funding and a history of funding cuts over the past decade. Expenditures, which are primarily comprised of personnel and facility costs, are moderately predicable given flat student enrollment levels. Districts have a moderate ability to reduce expenditures given above average fixed costs. Management reports the district has a formal cash balance policy to maintain a minimum of 5% and a maximum of 10% of budgeted operating expenditures in reserve. With the departure of the prior superintendent in Fall 2015, the Board tapped a 40-year veteran of APS to serve as interim. She was hired as the Superintendent in April 2016, and is focused on stabilizing the district in light of historic management turnover. Legal Security Both the bonds and notes are secured by ad valorem taxes that are levied against all taxable property within the district without limitation as to the rate or amount. Use of Proceeds Proceeds from the Series 2017 GO School Building Bonds will be used for various capital projects. Proceeds from the Series 2017 Education Technology Notes will be used for technology purchases. Obligor Profile The district serves the city of Albuquerque and surrounding area, covering approximately 1,200 square miles. Based on enrollment, the district is the largest in the state, serving 85,000 students (fiscal 2017), and is the 34th largest in the nation. APS operates 89 elementary schools, 27 middle schools, 13 high schools, two K-8 schools and 11 schools of choice. Methodology The principal methodology used in the underlying rating was US Local Government General Obligation Debt published in January The principal methodology used in the enhanced rating was State Aid Intercept Programs and Financings: Pre and Post Default published in July Please see the Rating Methodologies page on for a copy of these methodologies. Ratings Exhibit 2 Albuquerque Muni. SD 12 (Bernalillo Cnty), NM Issue Rating General Obligation Education Technology Notes, Series 2017 Rating Type Sale Amount Expected Sale Date Rating Description General Obligation School Building Bonds, Series 2017 Rating Type Sale Amount Expected Sale Date Rating Description 5 Aa1 Underlying LT $15,000,000 12/07/2016 General Obligation Aa1 Underlying LT $100,000,000 12/07/2016 General Obligation

6 General Obligation School Building Bonds, Series 2017 Rating Type Sale Amount Expected Sale Date Rating Description Aa2 Enhanced LT $100,000,000 12/07/2016 General Obligation Source: Moody's Investors Service 6

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