Nov 15 - Fitch Ratings has affirmed the following Royse City, Texas bonds at 'A-': --$308,000 general obligation (GO) bonds series 1976 and 2005; --$16.315 million combination tax and surplus revenue certificates of obligation (COs) series 2005, 2006, 2007A, and 2007B. The Rating Outlook is Negative. SECURITY Both GOs and COs are direct obligations of the city, payable from ad valorem taxes levied annually, limited as to rate to $2.50 per $100 assessed valuation; COs are also secured by a pledge of surplus net revenues of the city's waterworks and sewer (utility) system. KEY RATING DRIVERS NEGATIVE OUTLOOK MAINTAINED: The city's fiscal 2012 performance indicates a positive trend; however, the results are still preliminary and unaudited. Fitch believes that examination of the fiscal 2012 audit, fiscal 2013 preliminary results and the fiscal 2014 budget should provide further clarification of the city's evolving credit quality and inform future rating implications. RECOVERY PLAN PROGRESS: While still relatively illiquid, the city has made some measurable progress in its multi-year recovery plan, set on right-sizing financial operations and restoring general fund reserves to an adequate level within the projected timeframe. MODEST FINANCIAL CUSHION ESTABLISHED: Preliminary fiscal 2012 results indicate the city established a modest positive general fund balance, beating budgeted projections, and buoying operational pressures for the first time in six years. PLANNED REDUCTION OF UTILITY FUND SUPPORT: Inter-fund transfers from the utility fund to the general fund continue and now represent over one-fifth of total operating revenues, signifying the current structural imbalance of the city's primary operating fund. However, reductions of this support are planned to begin in fiscal 2014 as general fund revenues increase with the adjustment of the operational tax levy. HIGH OVERALL DEBT BURDEN: Direct debt levels are manageable, but overall debt ratios are very high when including debt from the local school district. STABLE TAX BASE: Rapid taxable assessed value (TAV) growth slowed in 2009 as housing construction stalled and general recessionary influences made their way to the city. TAV contracted only modestly in 2011 and 2012. Positively, sales taxes were fairly stable through the recession and expanded notably in 2011 and 2012 due to new retail activity in the city. WHAT COULD TRIGGER A RATING ACTION DEVIATION FROM RECOVERY PLAN: Failure to adhere to the recovery plan as currently scheduled will likely result in downward pressure on the rating. CREDIT PROFILE MODEST FINANCIAL CUSHION ESTABLISHED Royse City's credit profile remains stressed based on audited fiscal 2011 results. Preliminary fiscal 2012 results show a positive trend, but audited results are not yet available. The final 2012 audit, together with preliminary and budgeted figures for 2013 and 2014, respectively, will inform future rating implications. The city's previously negative general fund balance has turned positive with preliminary fiscal 2012 (ended September 30) results indicating a modest $260,000 unrestricted fund balance equal to 5% of expenditures. Unaudited net operating results for the year produced a surplus of $531,000 after transfers in, driven largely by revenue growth and cost controls, which Fitch views positively. 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 of negative $1.1 million in fiscal 2008 due to cost overruns, but steadily improved, albeit slowly, to negative $272,000 in fiscal 2011. UTILITY FUND TRANSFERS SUSTAIN GENERAL FUND OPERATIONS General fund operations remain imbalanced with recurring expenditures exceeding recurring general fund revenues in each of the seven fiscal years from 2007 through the 2013 budget. The city has had to rely on short-term financing and interfund loans to meet operating needs. In 2010 the city began supplementing general fund operations with interfund transfers from surplus revenues from the water and sewer fund. To supplement water and sewer fund operations, management made corresponding transfers from the debt service fund to pay utility-related debt service, thereby freeing up revenue available to be transferred to the general fund. While improving, liquidity is still weak. The utility-related debt was issued as double-barreled obligations, payable from property tax levies or utility system operating revenues. To meet the additional utility-related debt service payments, management raised the debt service tax rate by a notable $0.15 per $100 AV in fiscal 2009. RECOVERY PLAN TO RIGHT-SIZE OPERATIONS Management's stated plan to restore balance to the general fund involves small, incremental upward adjustments to the operating tax rate over the next few years (assuming flat TAV growth) with corresponding downward adjustments to the debt service tax rate. As the general fund moves towards balanced operations, inter-fund transfers will be reduced and eventually eliminated except for the usual administrative accounting reporting. Recovery plan progress in fiscal 2012 is evidenced by a modest but measurable shift in the debt service tax rate to the operating rate, in addition to the establishment of a positive fund balance. The fiscal 2013 budget further shifts the tax rate from debt service to the operating fund. However, operations are still supported by the same $1.09 million transfer in from the utility fund recorded in fiscal 2012, equaling roughly 20% of general fund revenues. Management states that utility fund transfers will trend down beginning in fiscal 2014 after general fund reserves reach targeted levels of approximately $1 million or 20% of expenditures. Fitch views this temporary operating support as appropriate given the strength of the utility fund, including its large $5.2 million cash position and the competitiveness of utility rates. The transfer from the utility fund to the general fund is being offset by the use of property tax revenues to service a comparable amount of utility system debt. As mentioned above, this shifting of funds is scheduled to wind down once general fund reserves reach the target level. STABLE LOCAL ECONOMY Located predominantly in Rockwall County, but also encompassing portions of Collin and Hunt counties, the city is conveniently located about 35 miles northeast of Dallas off Interstate 30. With an estimated 2011 population of 9,700 (up 230% since 2000), the city is a fast-growing bedroom community in the metroplex and benefits from its close proximity to three area lakes. TAV growth was strong from fiscal 2004-2009, averaging just over 20% annually. However, growth slowed considerably in fiscal 2010 to only 3%, and contracted modestly by 1% in both fiscal 2011 and fiscal 2012. Preliminary figures for fiscal 2013 TAV indicate 2% growth to $472 million. Independent housing information indicates relatively low mortgage delinquency and foreclosure rates and officials indicate no drop in current property tax collection rates. County wealth levels are above average, while unemployment rates remain below metropolitan, state, and national averages. Sales taxes have been remarkably stable throughout the recession, driven by growth in the city's retail corridor along a new highway interchange. Receipts for fiscal 2011 showed nearly 16% growth over the prior year, and receipts through October 2012 show 9% improvement. Wal-Mart has announced plans to build a store in the city beginning in 2013, which Fitch expects will further benefit city finances. HIGH BUT MANAGEABLE DEBT BURDEN Given rapid population and tax base growth, debt ratios have improved over time. Direct debt ratios are below average, while the overall debt ratio is high due to extensive borrowing by the local school district; overall debt totals a high $6,466 per capita, or 10.5% of total market value. Payout is average with 57% of debt repaid in 10 years. The city is in the process of developing a new capital plan, although given current financial and economic conditions, no additional borrowing is planned for the next five years. The city provides pension and other post-employment benefits (OPEB) through the Texas Municipal Retirement System (TMRS). Funding levels remain low at 69% but have improved recently; the city routinely funds 100% of annual required contribution (ARC) to TMRS. In fiscal 2011, the city's total fixed cost burden (debt, pension, and OPEB) was an average 20% of combined general and debt service fund spending.