OREANDA-NEWS. Fitch Ratings affirms the following ratings for the outstanding debt of Royse City, Texas (the city):

--$7,000 general obligation (GO) bonds series 1976 at 'A-';
--$12.1 million combination tax and revenue certificates of obligation (COs) series 2006, 2007A, 2007B, and 2013 at 'A-'.

The Rating Outlook is Stable.

SECURITY

Both the GOs and COs are direct obligations of the city, payable from ad valorem taxes levied annually, limited to $2.50 per $100 taxable assessed valuation (TAV). The COs are additionally payable from a limited (nominal), subordinate lien, not to exceed $1,000, of surplus net revenues of the city's waterworks and sewer (utility) system.

KEY RATING DRIVERS

STEADILY IMPROVING FISCAL POSITION: Management has made gradual, modest progress towards enhancing its reserve cushion and accomplishing other, stated financial objectives, such as improved budgetary and tax rate balance. Management expects continued positive momentum and further, modest additions to reserves, driven partly by an expectation of further strong sales tax gains and partly by continued, albeit declining, transfers from the utility fund to the general fund.

STRONG TAV GAIN: City sales tax and building-related revenues continue to perform strongly due to ongoing residential and some attendant retail/commercial development. TAV grew by a strong 12% in fiscal 2016 after recording a largely sluggish performance since the recession despite other positive economic indicators.

OVERALL DEBT HIGH: Overall debt levels are high and other long-term liabilities are moderate. Principal amortization of the city's direct debt is rapid. Capital needs appear manageable over the near term.

RATING SENSITIVITIES

PROGRESS TOWARDS OPERATIONAL BALANCE: The city appears poised to accomplish its financial objectives in the near to medium-term, which could position it for upward rating consideration. The city's ability to accomplish these objectives given ongoing growth-related spending pressures is an important rating determinant.

CREDIT PROFILE

DFW BEDROOM COMMUNITY

The city is conveniently located off Interstate 30, about 35 miles northeast of Dallas predominantly in Rockwall County, and encompasses roughly 10 square miles. Local income/wealth levels are mixed but generally exceed the state and nation and reflect higher than average growth in these metrics. With an estimated 2014 population of nearly 11,000 residents (almost four times the city's recorded population in 2000), the city is a fast-growing bedroom community that benefits from its close proximity to three area lakes. At 3.9% as of July 2015, county unemployment has favorably fallen on a year-over-year basis from 4.9% in July 2014.

RESERVE CUSHION IMPROVED

The city's historically thin financial margins turned negative at the end of fiscal 2007 when the downturn in the housing market and national economy caused revenues to fall short of budgeted expectations. Fund balances reached an alarming low negative $1.1 million in fiscal 2008 due to cost overruns, but since then have slowly and steadily improved.

Financial improvement has been steady since cost cutting measures and a substantial tax increase were implemented in fiscal 2009. The city has generated a modest net operating surplus annually over fiscals 2011-2014 in order to rebuild its reserve cushion, bolstered by growing sales tax revenues (21% of general fund operating revenues in fiscal 2014) and aided by a declining utility fund transfer. Fiscal 2014 year-end performance resulted in a $238,000 net addition to reserves, which brought the unrestricted general fund balance to a healthy $679,000 or 11.2% of spending, although this remained below the city's informal 25% reserve target.

Management anticipates fiscal 2015 unrestricted reserves will increase modestly to approximately $800,000 or nearly 14% of spending by year-end, enabled by continued utility fund support, conservative budgeting practices, and approximately $110,000 or 8% in additional sales tax revenue above budget. Sales taxes have generally recorded solid gains since fiscal 2011, driven by continued expansion of the city's retail corridor, particularly along a new highway interchange.

Year-over-year spending is up by a modest 1.3% per the adopted $6.8 million fiscal 2016 operating budget. Revenue assumptions in support of the year's budget include additional growth in sales and property taxes. A modest year-end addition to reserves ($80,000) is also planned, which Fitch recognizes is in part a function of the continued, modest step-down in the year's utility fund transfer ($690,000 or about 10% of the year's total operating revenues).

UTILITY FUND TRANSFERS HELP SUSTAIN GENERAL FUND OPERATIONS

The city has restored reserves, but general fund operations remain imbalanced with recurring expenditures exceeding recurring general fund revenues. The transfer from the utility fund to the general fund has been offset by the use of property tax revenues to service a comparable amount of utility system debt.

The city has historically issued utility-related debt as double-barreled obligations, payable from both property tax levies and utility system operating revenues. In 2009 the city raised the debt service levy a notable $0.15 per $100 AV to pay utility-related debt service and free up surplus water and sewer revenue available to be transferred to the general fund to supplement operations.

EVOLVING TAX RATE RESTRUCTURE TO REDUCE TRANSFERS

Starting in fiscal 2012, management has instituted small, incremental increases to the operating tax rate with corresponding downward adjustments to the debt service tax rate as part of the plan to reduce reliance on utility fund transfers and restore structural balance by fiscal 2018. Any stalling or reversal of recent positive momentum and financial gains would be a credit negative for the rating.

The process of restructuring the city's maintenance and operations (M&O) and debt service tax rates is constrained by weaker than anticipated TAV growth and a desire to keep the overall tax rate below the level that could trigger a rollback election by voters (possible when proposing a higher than 8% year-over-year operating tax rate increase). However, management's budgetary actions included the initial adoption of a tax rate above the rollback threshold for fiscal 2016 (totaling just under $0.68 per $100 TAV) that did not trigger a voter referendum and which remained well below the $2.50 per $100 TAV limit.

STRONG TAV GAIN IN FISCAL 2016

Affordable land and accessibility to the larger metro area employment base drove strong TAV growth from fiscal 2004-2009, averaging just over 20% annually. However, the pace of TAV expansion began to slow considerably beginning in fiscal 2010 as the recession unfolded. Tax base performance was sluggish through fiscal 2015.

Annexation of property outside the city limits along its Interstate 30 corridor and continued residential development supports management's expectations of further TAV growth over the near-term. Additional development is underway as state road improvements are nearly complete, providing improved north-south access through the city. This development includes construction of a Wal-Mart store, scheduled to open this month, a Buc-ee's Truck Stop, and other attendant retail/commercial projects, all of which Fitch believes are likely to drive additional TAV gains.

HIGH OVERLAPPING DEBT; NEAR-TERM CAPITAL NEEDS MANAGEABLE

Debt ratios have improved over time given rapid population and tax base growth but generally remain high. Overall debt ratios approximate $5,660 per capita or 8.9% of total market value, largely due to extensive borrowing by the local school district. Direct debt payout is rapid with roughly 80% of principal repaid in 10 years.

Presently about 45% of the city's outstanding tax-backed debt is self-supporting from enterprise system (water/sewer) revenues and therefore not included in Fitch's debt burden calculations. Annual debt service is fairly level at about $2 million through 2027, declining thereafter. The city has no outstanding GO bond authority, but management may consider a modest $2 million CO issuance for its water/sewer and related street needs in the next year that is planned to be repaid in part from utility revenues and have a minimal tax rate impact. Fitch expects management will maintain its historically conservative approach to future debt borrowings despite its growth pressures.

The city's pension and other post-employment benefits (OPEB) are offered through the Texas Municipal Retirement System (TMRS), a statewide agent multiple-employer plan. Contribution rates are determined each calendar year. The city's pension funded position is up slightly at 78% as of the last Dec. 31, 2014 actuarial valuation. Carrying costs for the city (debt service, pension, OPEB costs, net of self-supporting enterprise debt) totaled a moderate but manageable 22% of governmental spending in fiscal 2014 which incorporates the rapid principal amortization.