Fitch Rates Seguin, TX's LTGOs 'AA'; Outlook Stable

Fitch Ratings has assigned an 'AA' to the following city of Seguin, Texas' limited tax obligations:

--$19.8 million limited tax general obligation (LTGO) bonds, series 2014.

The bonds will sell competitively on Feb. 4. Proceeds will be used to fund a new library building, park improvements, and pay the costs of issuance.

Fitch also affirms its 'AA' rating on the following outstanding limited tax bonds:

--$32.5 million LTGOs;

--$16.1 million of combination tax and limited pledge revenue certificates of obligation (COs);

The Rating Outlook is Stable.

SECURITY

The bonds and outstanding LTGOs and COs are secured by a limited ad valorem tax levied against all taxable property in the city.

Outstanding COs are secured further by a limited, de minimis pledge (not to exceed $1,000) of the net revenues of the city's combined electric, waterworks, and sewer system.

KEY RATING DRIVERS

SOUND FINANCIAL PROFILE: The city consistently achieves general fund surpluses and has added to its fund and cash balances over a period of several years, yielding a robust fiscal cushion. Management demonstrates conservative budgeting practices and regularly outperforms budget forecasts.

HEALTHY, GROWING ECONOMY: The local economic base is small but fairly diverse and development activity and job growth in the city have been strong coming out of the recession. The city benefits from its location in the robust San Antonio metropolitan statistical area (MSA) economy.

WEAKER DEBT PROFILE: The city's overall debt levels increase to above average with this borrowing and the expected debt issuance by the local school district. Amortization is average while fixed costs for long-term liabilities are elevated relative to the budget. Concerns over the increased debt burden are tempered by the good tax base growth prospects.

WELL-FUNDED PENSION PLAN: City pensions are soundly-funded and the annual required contribution (ARC) is stable.

CONTINGENT LIABILITY FOR LOCAL HOSPITAL: The city has a contingent liability for 50% of long-term obligations and operating deficits at the city-county hospital. The city and county maintain significant oversight over hospital operations and budget and the city has never been required to transfer funds to cover a shortfall.

RATING SENSITIVITIES

SHIFT IN FUNDAMENTALS: The rating is sensitive to shifts in the city's credit fundamentals, including the sound fiscal profile and healthy economy, which are key mitigants to the above average debt burden. The Stable Outlook reflects Fitch's view that such shifts are unlikely.

HOSPITAL OPERATING RISK: Self-sufficiency of the city-county hospital remains key to offsetting credit concerns over the city's exposure to this contingent liability.

CREDIT PROFILE

Seguin is located in Guadalupe County, approximately 35 miles northeast of San Antonio along Interstate Highway 10. The city's 2012 population of 26,000 reflects 18% growth since 2000.

DIVERSE LOCAL ECONOMY FAVORABLY POSITIONED NEAR SAN ANTONIO

The local economy is fairly diverse in manufacturing, government, healthcare, and education. The city benefits from easy access to the extensive and broad employment base of San Antonio via major highways, including a recently completed toll road that connects San Antonio with Austin. The favorable location, highway access, and management's economic development efforts, including the use of tax abatement incentives, have facilitated economic development in the city, particularly in manufacturing.

Major Seguin employers include a number of manufacturers: Continental AG (formerly Motorola, 'BBB'/Stable Outlook), CMC Steel Texas, Tyson Foods Inc. ('BBB'/Positive Outlook), and Caterpillar Inc. ('A'/Stable Outlook). Continental AG is in the midst of a $113 million plant expansion to its Seguin site. Caterpillar opened in 2011 and currently employs about 1,400; the plant received a 100% tax abatement from the city through 2020. Other long-standing employers include a local medical center and Texas Lutheran University, a 1,400 enrollment liberal arts college.

Demographic indices are mixed and include lower income and educational attainment levels and a higher poverty rate relative to state and national norms. However, unemployment is low and per capita taxable market value is solid at $87,000, reflecting strong 8.2% compound annual growth in the past five years due to significant growth of the city's manufacturing base.

The natural gas boom occurring in south Texas has also spurred recent economic and job growth in the area. The Eagle Ford shale is a highly profitable natural gas play that stretches to just south of Seguin and has attracted business investment, jobs, and retail sales to the city. As such, the city's and San Antonio MSA's November 2013 unemployment rates each improved year-over-year to 5.2% and 5.6%, respectively, which are below state and national averages.

TOP TAXPAYER NOW TAX-EXEMPT; PILOT FUNDS MITIGATE BUDGET IMPACT

The Rio Nogales Power Plant, formerly the city's top taxpayer at 5% of fiscal 2011 taxable assessed value (TAV), was purchased by San Antonio's municipally-owned City Public Service (CPS) Energy in April 2012, at which time the plant became tax-exempt. The city's TAV declined by 4% in fiscal 2014 as a result, marking the first TAV decline in some time. As part of the purchase, CPS Energy paid to the city a one-time payment-in-lieu-of-taxes (PILOT) of $9.6 million for lost future tax revenues, relative to the estimated tax yield from the plant of $0.7 million in 2012.

The tax base is now without concentration and retains a good mix of residential and commercial/industrial properties. Prospects for future TAV growth appear favorable given the positive economic metrics, development that is occurring, and tax abatements that are scheduled to expire on a rolling basis over the medium to long term. Seguin's housing market is stable and property tax collection rates remain strong.

STRONG FINANCIAL MANAGEMENT PRACTICES AND PERFORMANCE

General fund revenues, led by sales and property taxes, have demonstrated strong 6.4% compound average annual growth coming out of the recession (fiscal years 2008-2012). This is compared to average annual expenditure growth (before capital transfers) of 5.3%, indicating structural budget balance. Sales taxes have performed particularly well, increasing by a compound annual average of 6% from fiscal years 2008-2012. They surged 23% in 2012 and 10% in 2013, largely due the upswing in gas drilling activity. Fitch recognizes the volatility associated with economically sensitive sales taxes, particularly when derived from highly cyclical oil and gas activities. Fitch views as prudent management's use of a portion of surplus revenues for non-recurring capital outlays, as well as the city's continued adherence to its formal policy of maintaining fund balance at or above 30% of spending.

Fiscal 2012 unrestricted fund balance doubled to $19.7 million (114% of spending) from $8.7 million (52% of spending) in fiscal 2011, due to the $9.6 million one-time PILOT payment for the power plant. General fund margins without considering this one-time payment were still positive in fiscal 2012.

The PILOT funds are classified as unassigned fund balance on an audit basis, although for budgeting purposes the city considers these funds to be distinct from the general fund and available for operational, debt service, and capital needs. Management plans to draw down on these funds over the next several years for ongoing expenses ($0.7 million annually) and one-time capital outlays, reducing the need for property tax increases. The city plans to transition away from this use of reserves for ongoing spending as the funds are depleted, timed to coincide with the expiration of large tax abatements in out-year budgets.

GOOD FISCAL CUSHION MAINTAINED IN 2013 & 2014

Fiscal 2013 estimated results are again expected to be slightly positive. The budget incorporated a partial year of the power plant's tax exemption. As such, management utilized $0.7 million of general fund balance (the PILOT funds) evenly between general operations and debt service while leaving the tax rate unchanged. The projections notably incorporate a mid-year transfer of surplus sales tax revenues for capital purposes. Unaudited general fund results for fiscal 2013 indicate a $0.5 million operating surplus which would push fund balance to $20.2 million or 96% of spending (inclusive of the PILOT funds from the power-plant).

The current-year (fiscal 2014) $23.1 million general fund budget reflects the first full year of the power plant tax-exemption. The budget adds some new staff and provides pay raises while again tapping the PILOT funds for operations and debt service. A $1 million deficit is presently forecast, which is consistent with prior-year budgets and with the city's plan for the use of the PILOT funds. Fitch expects that the city will maintain its positive financial performance and robust fiscal cushion over the near term based on its strong track record.

WELL-FUNDED LEGACY COSTS

The city participates in the Texas Municipal Retirement System (TMRS) for its retirees' pension program, and its annual contributions have been at or above the required amounts in recent years. Recent system-wide restructuring of internal fund balance reporting and actuarial assumptions benefitted many cities contributing to the system, including Seguin. Seguin's funded position improved to a sound 86.4% as of Jan. 1, 2012 from an estimated 72% in 2008 (using an investment return assumption of 7%). Other post-employment benefits (OPEB) for retiree healthcare are funded on a paygo basis. The OPEB plan is closed to new employees and the UAAL is a de minimis 0.1% of market value.

DEBT LEVELS INCREASING WITH THIS AND LOCAL SCHOOL DISTRICT DEBT ISSUANCE

The city's key debt ratios increase to above average levels (more than 6% of market value and $5,000 per capita) with this borrowing and when the planned borrowing by the local school district is incorporated. Voters approved both the city's and school district's borrowing authority in a November 2013 election -- each proposition passed with more than 60% approval. The debt service associated with the city's bonds is expected to require up to a 6% (3-cent) tax rate increase in fiscal 2015. The city's capital plan for fiscal years 2014-2018 identifies an additional $10 million in debt issuance out of $24 million in total identified spending, with the remainder to be funded by a mix of paygo, enterprise revenues, state appropriations, and grants.

Fixed carrying costs for debt service, the pension ARC (excluding the pension costs funded in excess of the ARC), and OPEB paygo made up 21.4% of fiscal 2012 governmental expenditures and will increase to a substantial 24% (based on current spending levels) in fiscal 2015 as the series 2014 debt service comes online. The fairly strong levels of community support for the debt issuance and the good tax base growth prospects for the area temper Fitch's concerns over the increasing debt burden. Additional debt issuance beyond what is currently expected would be a negative credit consideration.|

CONTINGENT LIABILITY FOR COUNTY-CITY HOSPITAL

The city and Guadalupe County (the county) each have a 50% contingent liability for operating deficits and shortfalls regarding long-term obligations of the Guadalupe Regional Medical Center (the hospital). Fitch would be concerned if hospital deficits exerted financial pressure on the city, but to date, the city has never made a subsidy payment to the hospital, other than indigent care costs for which the city is contractually responsible. Hospital operations have historically been positive, and although the hospital incurred a deficit in fiscal 2012 operating margins were positive in fiscal 2013 as utilization and revenues improved.

The hospital has $93.4 million in mortgage revenue bonds outstanding, issued in 2007 for an expansion project. The bonds are insured by the Federal Housing and Urban Development Program (Section 242) and are special and limited obligations of the hospital, HUD, and FHA. HUD has significant oversight authority for the hospital. The risk of the contingent liability is further mitigated by the fact that both the city and county maintain significant oversight of the hospital, including the appointment of board members, budget approval, and review of the hospital's audit.

Additional information is available at 'www.fitchratings.com'.

In addition to the sources of information identified in Fitch's Tax-Supported Rating Criteria, this action was additionally informed by information from Creditscope, University Financial Associates, S&P/Case-Shiller Home Price Index, IHS Global Insight, National Association of Realtors.

Applicable Criteria and Related Research:

--'Tax-Supported Rating Criteria' (Aug. 14, 2012);

--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 14, 2012).

Applicable Criteria and Related Research:

Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

U.S. Local Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=818450

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