Fitch Affirms McAllen, TX Water and Sewer Revs at 'AA+'; Outlook Stable

Fitch Ratings affirms the 'AA+' rating on the following revenue bonds of McAllen, Texas (the city) as part of its continuous surveillance effort:

--$61 million waterworks and sewer system improvement revenue and refunding bonds, series 2005 and 2006.

The Rating Outlook is Stable.

SECURITY:

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.

KEY RATING DRIVERS:

REDUCED COVERAGE, ROBUST LIQUIDITY: Debt service coverage levels declined in the most recent fiscal year due to unusually high rainfall totals which in turn resulted in lower consumption. However, system liquidity levels remain robust with over 400 days of cash on hand (DCOH).

MODERATE DEBT BURDEN: The system's debt burden is moderate on a per customer basis with above average amortization for the rating category.

AMPLE RATE FLEXIBILITY: The system exhibits ample rate flexibility, as combined utility rates fall well below Fitch's affordability threshold and are among the lowest of peer utilities.

STRONG FINANCIAL PLANNING AND POLICIES: The city performs 10 year financial analysis and maintains strong financial policies in regards to debt service coverage levels and the funding of reserves.

CREDIT PROFILE:

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 minimum debt service coverage (DSC) ratio of 1.5 times (x), and the city 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.

Financial results for fiscal 2010 were negatively impacted by an unusually wet season in which the city received 38 inches of rain, thereby cutting consumption of water dramatically. As a result, DSC declined to 1.6x in 2010 from 2.3x in 2009. Unaudited fiscal 2011 results show a modest improvement in DSC to 1.7x. Management provided forecasts depict DSC at reduced levels ranging from 1.5x to 1.8x from fiscal 2012 to 2016 as debt service costs related to capital improvement projects (CIP) rise.

System liquidity, taking into account funds reserved for the renewal and replacement of depreciable assets, has been consistently robust and approximates 400 DCOH at the close of fiscal 2011, which compares favorably to Fitch's category 'AAA' and 'AA' rating median.

Currently combined monthly user rates of approximately $40 per 10,000 gallon consumption are very affordable at 1.1% of median household income (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 a policy coverage level of 1.5x. While management review rates annually, there has not been a need for an increase since fiscal year 2007.

The system's service area is primarily residential, comprising approximately 42,000 water and 38,000 sewer customer accounts. Customer growth has been moderate, averaging approximately 2% 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. Capital projects related to the rehabilitation of wastewater facilities account for the bulk of the system's CIP for fiscal 2012 to 2016, which totals a moderate $92 million or $1,168 per customer. The city expects to fund the CIP with a combination of cash reserves and debt financing including low interest financing through programs administered by the Texas Water Development Board.

The system's current debt burden is moderate for the rating category with debt per capita of $577 compared to the 'AA' median of $410. The system's pace of principal amortization compares favorably to other utilities in the rating category.

The city (general obligation bonds rated 'AA+' by Fitch) has an 2010 census population of 129,000 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's unemployment rate at 7.7% for October 2011 is relatively unchanged from the year prior, and compares favorably with the state (8.4%) and national (8.8%) averages.

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

Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

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 and Municipal Advisory Council of Texas.

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria', dated June 20, 2011;

--'Water and Sewer Revenue Bond Rating Guidelines', dated Aug. 10, 2011.

--'2012 Water and Wastewater Medians', dated Dec. 8, 2011.

--'2012 Outlook: Water and Wastewater Sector', dated Dec. 8, 2011.

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=637130

U.S. Water and Sewer Revenue Bond Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647331

2012 Water and Sewer Medians

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=657111

2012 Outlook: Water and Sewer Sector

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=657110

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