OREANDA-NEWS. Fitch Ratings has affirmed the following bonds of Mercedes, Texas (the city):

--$1.5 million limited tax general obligation (GO) refunding bonds, series 2010 at 'A+';

--$6.1 million combination tax and limited pledge revenue certificates of obligation (COs), series 2006, 2006A, and 2007 at 'A+'.

The Rating Outlook is Stable.

SECURITY

Outstanding GO bonds and COs are both secured by a property tax limited to $2.50 per $100 of taxable value. The outstanding COs are further secured by a limited pledge (not to exceed $1,000) of net revenues of the water and wastewater utility system.

KEY RATING DRIVERS

SOLID FINANCIAL RESERVES: The city maintains structurally balanced operations and expects to preserve a strong general fund balance despite recent drawdowns for pay-as-you-go capital spending.

SALES TAX DEPENDENCE: Sales taxes comprise about half of general fund revenues. Credit concerns regarding the city's dependence on this economically sensitive revenue source are somewhat tempered by the city's strong reserve levels and room under the statutory property tax rate limit.

MIXED DEBT PROFILE: The city's overall debt levels are moderate on a per capital basis, but represent a high percent of market value, resulting from the city's low property wealth and significant overlapping debt. However, amortization is rapid while the city's capital needs and carrying costs remain moderate.

BELOW AVERAGE ECONOMIC INDICATORS: This small border city's socioeconomic metrics remain well below average but have continued to improve, aided by overall growth in the McAllen-Edinburg-Mission Metropolitan Statistical Area (the MSA).

GROWING BUT CONCENTRATED TAX BASE: TAV trends have recently strengthened due to overall growth in the larger MSA spurring development as well as tax base appreciation. Nonetheless, the city's tax base remains small and concentrated; an outlet mall is the leading top taxpayer at 14% in fiscal 2015.

RATING SENSITIVITIES

STRONG FISCAL CUSHION: The maintenance of strong general fund reserves and ample liquidity is key to credit stability as it serves to mitigate the risks posed by the city's tax base, modest scale, dependence on sales tax revenue, and reliance on the outlet mall.

CREDIT PROFILE

The city of Mercedes, located within Hidalgo County (the county) (LTGO Rated 'AA-'; Stable Outlook), encompasses approximately 9 square miles about 5 miles north of the Mexican border. The 2015 estimated population is roughly 16,600.

ECONOMY BENEFITS FROM PROXIMITY TO MCALLEN

The local economy is largely rooted in retail and local government, with the Rio Grande Valley Premium Outlet Mall as the city's top employer. The mall provides a city-estimated 1,400 - 1,500 full- and part-time jobs. Proximity to the more diverse economy of the McAllen-Edinburg-Mission MSA, with solid growth in international trade, healthcare, and higher education components, mitigates some of the risks posed by Mercedes' economic concentration. The nearby and newly established University of Texas-Rio Grande Valley campus and medical school has recently spurred some modest healthcare-related development for the city. Fitch believes other similarly-oriented projects either planned or underway in addition to some associated growth in attendant retail/commercial and housing may allow for modest economic and tax base expansion in the near-term.

TAV REBOUNDS ALTHOUGH CONCENTRATION PERSISTS

Strong annual growth in the city's tax base is comparable to its pre-recessionary performance. TAV grew by approximately 14% to $522 million in fiscal 2015 after remaining largely flat over the four prior fiscal years. Another strong TAV gain was recorded in fiscal 2016. Still, market value per capita held to a relatively modest $43,000. The tax base remains concentrated; the top ten taxpayers (inclusive of the outlet mall) contributed a high 22% of TAV in fiscal 2015, although the top taxpayer list represents a variety of industries.
Unemployment levels have been historically high and income levels low, like many other border communities. County unemployment dropped to 7.9% in August 2015 from 9.1% the year prior, although this remained well above the rates of the state (4.4%) and nation (5.2%). The MSA's median household income equals roughly 50% of state and national averages despite its strong growth rate that outpaced the state and nation.

SALES TAXES ARE KEY REVENUE STREAM

Sales taxes represent the largest share of operating support at about 50% of fiscal 2014 general fund revenues or $5.5 million. The receipt of additional sales tax revenue for operations (about $1 million) is projected to begin in fiscal 2017 as the city concludes its economic incentive agreement with the outlet mall to rebate 50% of the sales tax generated. Given the importance of the outlet mall and sales taxes to city operations, management maintains an insurance policy guaranteeing one year of sales taxes in the event of business interruption at the mall.

Property taxes have consistently contributed 22% of general fund revenues ($2.5 million in fiscal 2014) while growing sales tax revenues and property values have allowed management to slowly reduce the higher than average property tax rate. Since the opening of the mall in 2006, the city's total property tax rate has gradually declined by a notable $0.11 from $0.87 per $100 TAV to $0.76 per $100 TAV in fiscal 2015; these reductions provide a measure of revenue flexibility for the city.

STRONG FINANCIAL POSITION MAINTAINED

The city has maintained sizable general fund balance reserves as a percentage of spending over at least the last ten fiscal years and more recently decided to use a portion for its key capital projects. Fiscal 2014 unrestricted general fund balance totaled 47.3% of spending or about $6 million after the year's net $1.8 million drawdown was used to partially fund a new fire station. Reserves remained well above the city's informal but conservative policy of maintaining four months of operations in reserve. Liquidity declined year-over year, but remained sound as general fund cash and investments totaled $4.6 million or slightly over five months of operations.
The city's general operations continue to maintain structural integrity as evidenced by balanced and generally flat operating budgets adopted thru fiscal 2016 ($10.8 million). Actual sales tax performance in fiscal 2015 held to the year's budget estimates and the planned use of $2.5 million in reserves to complete an emergency dome shelter is projected to preserve fund balance at roughly $3.4 million or a still strong 31% of budgeted spending.

The city recently expanded its utility through the purchase of a sizeable portion of another local utility's system and infrastructure in order to strategically ensure future commercial/retail growth in the city's highway corridors. Management expects to consider a utility rate increase shortly, due in large part to the expanded operations. If the increase is adopted, Fitch would not expect this utility acquisition to pressure the city's general fund operations, reserves or liquidity.

MIXED DEBT PROFILE

Overall debt to market value in fiscal year 2015 was a very high 15%, largely attributable to the size of the city's tax base and significant borrowing by the school district, although this does not reflect the offsetting state support received by the district for its debt (about 60% of its fiscal 2015 debt service). Overall debt per capita was also elevated at roughly $5,000.

The city amortizes its direct debt at a rapid pace with 82% of principal retired within the next 10 years. Utility revenues support roughly a third of the city's outstanding tax-backed debt. Fitch considers the city's near-term capital needs to be reasonable and does not expect its capital plans will stress overall financial flexibility. Management anticipates further success in obtaining some grant funding from the state and federal government for particular capital projects.

ADEQUATE PENSION FUNDED POSITION

City employee pensions are provided through the Texas Municipal Retirement System (TMRS), a state-wide, agent-multiple-employer plan. Recent annual pension contributions made by the city since fiscal 2008 reflect the plan's allowable phase-in of the higher, actuarially-calculated annual required contribution (ARC) until fiscal 2016. The city's pension funded position improved slightly to 70.2% as of its Dec. 31, 2014 valuation, up from 65.6% the year prior, using the system's 7% investment return. This gain was due in large part to the year-over-year growth in the plan's actuarial valuation of assets.

Other post-employment benefits (OPEB) are funded on a pay-go basis and budgeted annually, subject to changes in benefits at the city's discretion. The unfunded liability for the city' OPEB totaled a modest 1.2% of full market value. Carrying costs, including debt service, TMRS contributions, and OPEB spending, made up a moderate 13.5% of total governmental spending in fiscal 2014.