Fitch Ratings assigns an 'AA+' rating to the following McAllen, TX (the city) bonds:
--Approximately $17.4 million waterworks and sewer system revenue refunding bonds, series 2015.
Fitch also affirms the 'AA+' rating on the following outstanding bonds:
--$53.8 million waterworks and sewer system improvement revenue and refunding bonds, series 2005 (pre-refunding) and series 2006.
The Rating Outlook is Stable.
SECURITY
The bonds are payable from a first lien on net revenues of the city's water and sewer system (the system). A debt service reserve will not be funded for the series 2015 bonds.
KEY RATING DRIVERS
REDUCED COVERAGE TREND: Annual debt service coverage (DSC) has trended below 2 times (x) for the last four fiscal years, and unaudited results for fiscal 2014 point to weak coverage of 1.5x due primarily to weather events. Somewhat offsetting the concern over reduced DSC is the system policy of healthy reserves and the strong unrestricted cash position of more than 400 days of operations on hand.
AVERAGE BUT GROWING DEBT BURDEN: The system's average debt burden will growing in the coming five years due to rehabilitation of one of its wastewater treatment plants. Debt per customer of $1,235 is favorable compared to the 'AA' median of $1,812 and should remain in line with 'AA' medians over a five year forecast period.
EXCEPTIONAL RATE FLEXIBILITY: Combined utility rates are very affordable and among the lowest of peer utilities. Despite recent and planned increases, user rates retain significant flexibility, falling well below Fitch's affordability threshold of 2% of median household income (MHI).
STRONG FINANCIAL PLANNING AND POLICIES: The city performs 10-year financial forecasts and maintains strong financial policies regarding DSC and reserve funding.
DIVERSE INTERNATIONAL ECONOMY: The city is a major commercial and industrial hub in the Rio Grande Valley along the U.S.-Mexico border. Commercial trade with Mexico, healthcare, government, and retail provide a well-diversified economic base that complements the traditional agriculture and tourism sectors.
RATING SENSITIVITIES
DETERIORATION IN FINANCIAL PERFORMANCE
Negative rating pressure may result from continued low coverage levels, failure of adopted and planned rate increases to achieve management's forecasted DSC levels, and failure to increase free cash to deprecation to levels more consistent with Fitch's category median.
CREDIT PROFILE
The system's service area is primarily residential, comprising approximately 44,000 water and 39,000 sewer customer accounts. Customer growth has been moderate, averaging approximately 1.3% over the last five years.
AMPLE TREATMENT CAPACITY
The city purchases untreated water pursuant to long-term, permanent contracts with various water districts; existing water rights of more than 40,000 acre feet (or 35 million gallons per day) are deemed sufficient to meet projected demand for the next 20 years. The system's water treatment capacity of 59.5 mgd is more than adequate to meet average daily demand of 23 mgd. The city is in the process of expanding one of its two water treatments plants by four million gallons a day (mgd).
The system also owns and operates two wastewater plants with permitted treatment capacity of more than 21 mgd, capable of readily meeting the average daily demand of 12 mgd. The system capital improvement plan (CIP) includes a complete rehabilitation of the south wastewater treatment plant. It is expected that the system expansion and upgrade projects will provide the city with water and wastewater treatment capacity for the next 15-20 years.
STRONG FINANCIAL PLANNING
The system has a history of healthy financial performance, exhibited by strong debt service coverage levels and balance sheet liquidity. Management budgets conservatively, and Fitch notes that actual results are typically better than projections. A 10-year financial plan is prepared targeting 1.5x DSC and a minimum of 120 days of working capital (per policy). The city also annually funds depreciation and capital improvement reserves. These financial practices and policies are indicative of strong financial management and seen as positive credit factors by Fitch.
TREND OF DECLINING COVERAGE
Coverage levels have been on a downward trend after historically posting above 2x DSC. In fiscal 2010 financial results were negatively impacted by an unusually wet season, cutting consumption of water dramatically and resulting in DSC of 1.6x. With debt service costs growing 20% from fiscals 2010 to 2011, coverage levels have remained below historical norms but improved to a healthy 1.8x for fiscals 2011 and 2012. Fiscal 2013 results of 1.6x DSC were in line with projections, but heavy rains in the system's peak revenue months once again resulted in weaker 1.5x DSC for fiscal 2014 (unaudited).
CONSUMPTION DECLINE MUTES RATE IMPACT
The reduced consumptions levels muted the impact of the system's 7% water and almost 4% sewer rate increases in adopted at the start of the fiscal 2014. The city commission adopted an 11% water and 7% sewer rate increase effective at the start fiscal 2015. Management forecasts suggest a rebound to 1.8x DSC from fiscal 2015 through at least fiscal 2018, growing to 1.9x by fiscal 2020. The reduced coverage levels are not consistent with an 'AA+' rated credit. However, the system's strong financial policies and robust liquidity offset temporary concerns over weaker DSC levels.
System liquidity remains strong due to management policies of setting aside funds for depreciation of assets and capital improvement projects. Unrestricted cash, combined with the depreciation reserve, have produced solid DCOH figures of at or near 400 days cash since fiscal 2009; this total compares favorably with Fitch's category 'AAA' and 'AA' rating medians.
GENEROUS RATE FLEXIBILITY
Currently, combined monthly user rates of approximately $42 per 10,000 gallons of consumption (average monthly residential water use) are very affordable at 1.2% of MHI, well under Fitch's affordability threshold of 2%. User rates are some of the lowest in the region and the state. Management routinely budgets rate increases as needed to maintain its 1.5x DSC policy and reviews rates annually. City commission has been supportive of rate adjustments in order to maintain the system's financial health. Recent rate adjustments have focused on increasing the fixed base rate in an effort to reduce revenue volatility. Additional sewer rate increases of about 5% are planned for fiscal years 2016 and 2017, with no additional water rate hikes planned for the same period.
MANAGEABLE CAPITAL PLAN
Capital projects through fiscal 2018 total $155 million (or $1,868 per customer) and focus primarily on the system's sewer system. The upcoming rehabilitation of the system's south wastewater treatment plant (SWWTP) is estimated to cost $55 million and will be partially financed with a $38 million low interest loan from the state revolving fund in 2015. The city expects to debt-fund roughly 60% of the CIP, starting with the state loan for the SWWTP expansion. The city expects to fund the remainder of the capital plan with a combination of cash reserves and system revenues.
Debt per customer of $1,235 compares favorably to the 'AA' median of $1,812. Taking into account planned debt financing of the CIP, projected debt per customer in five years grows to $1,820, which compares favorably to the 'AA' median of $1,973. The system benefits from relative rapid debt amortization- 55% of principal is retired in 10 years.
FAVORABLE SERVICE AREA ECONOMICS
McAllen (general obligation bonds rated 'AA+', Stable Outlook by Fitch) has an estimated 2013 population of 136,000 and is located in Hidalgo County, approximately 230 miles south of San Antonio and seven miles north of the border from Reynosa and Tamaulipas, Mexico. The city is part of a rapidly growing metropolitan statistical area (MSA) that includes the cities of Edinburg and Mission, as well as populous neighbors south of the border. McAllen has benefited from trade with Mexico, with government, tourism and agriculture components rounding out the local economy.
The city posted a favorable unemployment rate for October 2014 of 5.3%. This rate was largely on par with the state's 4.8% and nation's 5.5% averages, but below the MSA's 7.9%. Wealth levels for 2013 were 79% and 78% of the state and national averages.
Additional information is available at 'www.fitchratings.com'
In addition to the sources of information identified in Fitch's U.S. Municipal Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria' (June 2014);
--'U.S. Water and Sewer Revenue Bond Rating Criteria' (July 2013);
--'2015 Water and Sewer Medians' (December 2014);
--'2015 Sector Outlook: Water and Sewer' (December 2014).
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012
U.S. Water and Sewer Revenue Bond Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715275
2015 Water and Sewer Medians
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=818409
2015 Outlook: Water and Sewer Sector
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=818410
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=971175
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