Fitch Rates Montgomery, TX COs 'BBB-'.

AUSTIN, Texas -- Fitch assigns a 'BBB-' rating to Montgomery, Texas' (or the city) $2.4 million tax and revenue certificates of obligation (COs), series 2005B. The COs are scheduled to sell competitively on Nov. 8. Coastal Securities is the city's financial advisor. In addition, Fitch affirms the 'BBB-' rating to the city's outstanding tax and revenue COs. The Rating Outlook is Stable.

The COs are secured by ad valorem taxes levied within the city within the limits prescribed by law. Additionally, the COs have a limited pledge, not to exceed $10,000, of a subordinate lien on net revenues of the city's water and sewer system. Proceeds will be used to fund the construction and improvements to the water and sewer system and to pay costs of issuance.

The rating reflects this small but fast-growing city's solid reserve levels, expanding taxable assessed values (TAV), and the absence of additional borrowing plans for the next five years. The rating also incorporates taxpayer concentration and dependence on economically sensitive sales taxes for operations. With this offering, debt ratios climb to very high levels and payout is slow. However, some concern is offset by the identification of a separate non-property-tax revenue stream for CO repayment as well as extensive ongoing and planned development which should bring down debt ratios to more manageable levels within the near term.

The city is located in fast-growing Montgomery County, within commuting distance of the broad-based Houston metropolitan economy. The city, with a population of only 535, continues to experience rapid TAV growth, averaging about 16% annually over the past five years. Officials point to the city's desirable location near Lake Conroe as well as the strong area school district as key factors in promoting the rapid development. Currently there are more residential permits under review by the city than there are existing homes, with additional residential developments in the planning stages. In addition, the recent completion of a portion of the Lone Star Parkway is expected to drive commercial growth in the city and its extra-territorial jurisdiction. There is taxpayer concentration, with the largest taxpayer (a mall) representing nearly 18% of total TAV. However, with continued development, concentration is expected to diminish over time. Economic indices for the county reflect above-average wealth levels and a 2004 unemployment rate of 5%, below state and national norms. In addition, the city's TAV per capita is above average.

Financial results point to the maintenance of strong reserve levels, with the general fund balance for fiscal 2004 representing 42% of expenditures and transfers out. The city maintains a goal of six months of operations in reserve, and ultimately hopes to maintain one full year's operation in fund balance. Maintaining large reserve levels is important given the city's substantial dependence on sales taxes for support. In fiscal 2004, sales taxes accounted for over 50% of general fund operating revenues. Gains in sales tax collection have been impressive, with growth averaging nearly 17% annually from 2001-2004.

Preliminary fiscal 2005 results show a more modest growth of 6.2%, but that figure is coming off a fiscal 2004 increase in collections of nearly 27% over the prior year's level. Some concern over the reliance on sales taxes is mitigated by the absence of a big box retailer within the city. Much of the sales taxes are in fact generated from the city's position as a regional antique center for the area.

Fines, forfeits, and warrants account for the next largest revenue source, representing about 34% of general fund operating revenues. While there has been some fluctuation in the collections, officials state that greater attention has been paid to improving the budgeting of these revenues. In addition, the recent hiring of a full-time city administrator appears to have improved budgetary planning and oversight. Property taxes, given the city's relatively small tax base, represented less than 6% of revenues in fiscal 2004.

Although this offering was not planned at the time of the CO issuance in March 2005, the water and sewer improvements funded with the 2005B COs are needed in order to meet development demands on the western portion of the city. Debt service on the 2005B COs is expected to be met entirely through an interlocal agreement with the Montgomery Industrial Development Corporation (MIDC), which levies a one-half-cent sales tax throughout the city. The MIDC is a Texas non-profit corporation organized under the approval and direction of the city of Montgomery for the purpose of promotion and economic development. The city appoints MIDC board members, which include several city council members, and thus maintains significant oversight of MIDC operations. Debt service coverage by fiscal 2004 MIDC sales taxes provides 1.2 times (x) coverage of maximum annual debt service on the 2005B COs. Unaudited fiscal 2005 collections provided 1.4x coverage.

Adjusting for self-support of the 2005B COs, overall debt ratios, although high, are still manageable at 8.8% debt to TAV and $5,200 debt per capita. Excluding self-support, overall debt ratios climb to a very high 16.3% and $9,700 debt to TAV and debt per capita, respectively. Payout is also slow, with only 15% paid in 10 years, with all debt repaid in 30 years. Debt ratios should moderate as the city is projected to record rapid tax base and population growth. However, further debt issuances in the near term could jeopardize the rating.

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