Fitch Rates Houston Comm College, TX Maint Tax Notes 'AA'.

AUSTIN, Texas -- Fitch Ratings assigns an 'AA' rating to the Houston Community College System (HCCS), Texas, $12 million maintenance tax notes, series 2006, scheduled to be sold on Feb. 14 via negotiation to Citigroup Securities LLC. Fitch also affirms the 'AA' rating on the system's outstanding $144.7 million limited tax bonds. The Rating Outlook is Stable.

The notes are direct obligations of the system and are payable from the proceeds of a maintenance and operations tax levied against all taxable property within system boundaries, subject to a $0.50 per $100 assessed valuation (AV) limitation. Proceeds will be used for the renovation and equipment of existing facilities and pay issuance costs.

The 'AA' rating for the Houston Community College System's (HCCS) maintenance tax notes is based on an extensive and growing service area and tax base, a modest general obligation debt position, and stable finances and existing financial flexibility. Also considered in the rating are service delivery pressures anticipated from projected enrollment growth and governance challenges associated with a large, diverse service area.

The system's low operating tax rate coupled with the availability of significant taxing margin provides financial flexibility in light of recent reductions in state appropriations. HCCS also maintains some pricing flexibility through its tuition and fees, which are markedly lower than area four-year public institutions. Potential annexations, while likely to increase operating and capital needs, would also generate substantial property tax receipts for the system.

HCCS serves a large portion of the broad and diverse Houston metropolitan area, with a population of 1.9 million. In addition to its taxing jurisdiction, the system offers programs at several neighboring school districts within its service area. While overall enrollment gains have been modest, prospects for future growth appear favorable, given demographic trends of the service area, as well as the potential for annexation. Partly due to highway construction near two campuses, fall 2005 enrollment did decline by almost 5% although contact hours remained nearly level. Year-to-date spring 2005 enrollment figures indicate recovery is underway.

The fiscal 2005 operating margin is positive at 4.1%. Break-even operations are typical for public institutions. In addition, liquidity is levels are adequate with available funds to expenses representing about three months of operations. While reductions in state appropriations have pressured operations and required expenditure cuts, financial performance has been enhanced by tuition increases as well as growth in taxable resources.

The system maintains significant financial flexibility. The size and steady growth in taxable assessed values (TAV) have enabled HCCS to maintain a very low property tax rate in comparison to other community colleges in the state. In addition, while tuition and fees are about average in comparison to those of other community colleges, they remain well below those of four-year public institutions, particularly given recent state legislative approval for tuition deregulation.

Voters approved in 2003 an authorization of approximately $150.8 million for phase I of its plan to increase its instructional space per student, currently well below the national average. Officials plan to supplement phase I with an additional $83 million of either voter-approved debt or maintenance tax notes for additional site improvements, information technology infrastructure needs, and Hurricane Katrina and Rita-related construction inflation. Given the size of the system and gains in TAV, direct debt ratios and debt service tax impact are modest. Payout is slow. HCCS maintains a sizable amount of revenue bond and capital lease debt, which contributes to an above-average maximum annual debt service (MADS) burden as a percentage of operating revenues.

HCCS is proposing to annex four school districts within its service area. If the annexation is approved by the voters in fall 2006, an additional $164 million in capital financing will be needed to add instructional space in the annexed areas. The additional debt may be issued in the form of lease revenue bonds through the system's recently created public facility corporation. However, taxable values of the proposed annexed areas are significant and would increase the system's taxable values by nearly 44%.

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