City of McAllen News

Fitch Affirms McAllen, Texas' Water and Sewer Revs at 'AA+'

by Fitch Ratings | Dec 20, 2013

December 12, 2013 09:08 AM Eastern Standard Time

AUSTIN, Texas--(BUSINESS WIRE)--Fitch Ratings affirms the 'AA+' rating on the following bonds for McAllen, TX (the city):

--$56.8 million waterworks and sewer system improvement revenue and refunding bonds, series 2005 and 2006.

The Rating Outlook is Stable.


The bonds are secured by a pledge of a first lien on net revenues of the city's water and sewer system (the system). Bonds are also secured by a debt service reserve fund provided by a surety policy equal to average annual debt service.


REDUCED COVERAGE TREND: Annual debt service coverage (DSC) has trended below 2 times (x) for the last three fiscal years due to growing debt service costs. Offsetting concerns over reduced DSC is the system's strong cash position of over 450 days of cash on hand (DCOH).

AVERAGE BUT GROWING DEBT BURDEN: The system's debt burden is mixed with debt per customer on par with the 'AAA' rating category median, while debt per capita figures are elevated. The debt profile will grow in the coming years with the planned debt financing of the upcoming wastewater treatment plant rehabilitation.

EXCEPTIONAL RATE FLEXIBILITY: Combined utility rates are very affordable and among the lowest of peer utilities. User rates retain significant rate 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 analysis and maintains strong financial policies in regards to DSC levels and the funding of reserves.


DETERIORATION IN FINANCIAL PERFORMANCE: Diminished financial flexibility characterized by a material decline in liquidity and reduced ADS coverage below policy levels would be inconsistent with the 'AA+' rating category. As such, it would likely lead to negative rating pressure.


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 1.5% over the last five years. The city purchases untreated water pursuant to long-term, permanent contracts with various water districts; existing water rights are deemed sufficient to meet projected demand through the next 20 years. The system owns and operates two wastewater plants. The recent expansion of one facility provides adequate capacity for the near future.


The system has a history of healthy financial performance, exhibited in 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 a 1.5x DSC and a policy of maintaining a minimum of 120 days of working capital. The city also annually funds depreciation and capital improvement reserve funds. These financial practices and policies are indicative of strong financial management and seen as positive credit factors by Fitch.


While the city has historically posted very healthy DSC of 2x or higher, coverage levels have been on a downward trend. 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 increasing 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.

Management-provided forecasts, which appear reasonable, point to DSC of below 1.6x in fiscals 2013 and 2014. As planned rate increases are implemented DSC is expected to gradually improve and grow to 2x by fiscal 2020. The reduced coverage levels over the near-term are not necessarily indicative of 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 funds. Current unrestricted cash, combined with the reserve for depreciation resulted in solid DCOH figures of at or near 400 days cash since fiscal 2009. This compares favorably to Fitch's category 'AAA' and 'AA' rating medians.


Currently, combined monthly user rates of approximately $31 per 7,500 gallon consumption are very affordable at 1% of MHI, well under Fitch's affordability threshold of 2% of MHI. User rates are some of the lowest in the region and the state. Management routinely budgets for modest rate increases as needed to maintain its 1.5x DSC policy. Rates are reviewed annually and the governing body adopted a 5% rate increase in fiscal 2009. Additional rate increases are anticipated starting in fiscal 2014 and running through fiscal 2017. The focus of the increases will be to increase the base rate for water customers while also making some incremental increases to the volumetric rate.


Capital projects through fiscal 2015 total a manageable $78 million (or $959 per customer) and focus primarily on the rehabilitation of the south wastewater plant (SWWP). Rehabilitation of the SWWP is expected to be financed with low interest loan programs administered by the state. The related debt of approximately $38 million will grow the system's debt profile by almost 30%.

The city expects to fund the remainder of the capital plan with a combination of cash reserves and system revenues. Rising debt concerns are somewhat mitigated by the system's above-average pace of principal amortization - 46% of principal is retired in 10 years. Also, debt to net plant assets of 51% is comparable to the 'AA' rating category median of 49%.


The city is part of a rapidly growing metropolitan statistical area (MSA) that includes the cities of Edinburg and Mission, Texas, as well as populous neighbors to the south of the border. The city has benefited from trade with Mexico, with government, tourism and agriculture components rounding out the local economy.

The city (general obligation bonds rated 'AA+' by Fitch) has an estimated 2012 population of 134,000 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 posted a favorable unemployment rate of 6.8% in October 2013. This was slightly above the state's 6%, but below the MSA (10.1%) and the nation (7%). Wealth levels for 2012 are 81% and 80% of the state and national averages, respectively, a 4% increase from the prior year.

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