Fitch Ratings has affirmed the Mexican municipality of Apodaca's Long-Term (LT) Local Currency (LC) Issuer Default Rating (IDR) at 'BBB-' and National Long-Term Rating (NLTR) at 'AAA(mex)', both with a Stable Rating Outlook.

The municipality's standalone credit profile (SCP) is 'bbb+'; however, the LC IDR is capped by Mexico's sovereign rating of 'BBB-'/Stable, reflecting Fitch's view that a subnational in Mexico cannot be rated above the sovereign.

The rating affirmations reflect Fitch's expectations that Apodaca's debt sustainability metrics and risk profile will remain stable over a five-year rating horizon (2022-2026) based on its good historical financial performance supported by its dynamic economy, which recovers notably as the health contingency subsides. This is reflected in strong revenue growth prospects for the coming years and the continuity of significant levels of unrestricted cash despite the noticeable impact of the pandemic on Apodaca's public finances in 2020 and 2021.

KEY RATING DRIVERS

Risk Profile: 'Low Midrange'

Fitch assessed Apodaca's risk profile at 'Low Midrange'. This reflects a 'Midrange' assessment for the key risk factors (KRFs) of revenue robustness, expenditure adjustability and sustainability, and liabilities and liquidity robustness and flexibility. Revenue adjustability is assessed as 'Weaker'. The 'Low Midrange' risk profile reflects a moderately high risk of an unexpected weakening of Apodaca's ability to cover its debt service needs over the scenario horizon relative to international peers, either because of revenue falling short of expectations or spending above expectations, or an unanticipated rise in liabilities/debt.

Revenue Robustness: 'Midrange'

KRF assessed as 'Midrange' for Apodaca because the operating revenue is closely related to the performance of the national transfers, coming from the sovereign rated in 'BBB-', as they have stood for more than half of Apodaca's operating revenue. Fitch deems these resources as strong, as they present a stable trend and come from a trustworthy source with a supportive framework.

Over 2017-2021 period the growth rate of Apodaca's operating revenue has been higher than the real national GDP growth (the operating revenue's CAGR in real terms was of 2.1% as compared to GDP's CAGR of -0.4%), except in 2020 and 2021 due to the impact of the pandemic on own-source revenues and upper-tier transfers. Property tax revenues and transfers received have demonstrated stability, averaging 70.1% of Apodaca's operating revenue in 2017-2021. In 2020 operating revenue shrank in line with the national GDP contraction.

Real estate transfer tax revenue plummeted due to the sector's slowdown. In 2021, own-source revenues began to recover, supported by the municipality's economic structure, which is linked to the U.S. economy. However, transfers' performance remained sluggish. For 2022 and the coming years, operating revenue growth is expected to be positive due to a higher local revenue collection linked to the economic recovery as well as a larger amount of federal transfers received, which are allocated according to defined formulas.

Revenue Adjustability: 'Weaker'

Like almost all other Fitch-rated Mexican municipalities, Fitch assesses Apodaca's revenue adjustability at 'Weaker' because the municipality's ability to generate additional revenue in response to economic downturns is limited and it requires political approval from the state congress and local council. The cadastral register is also managed by the state of Nuevo Leon. Another difficulty to adjust tariffs has to do with the competition among other municipalities to attract investment, particularly in the metropolitan area of Monterrey.

Apodaca maintains a collection management program through a specialized firm to recover past-due portfolios of the property tax. In 2021, tax revenue rebounded by 41.2% triggered by the economic recovery; real estate transfer tax collection surpassed pre-pandemic levels. As of March 2022, tax collection has grown by 23% yoy due to taxpayer confidence and fiscal audits. Fees revenues have also increased significantly supported by the reduction of fiscal stimulus, avoiding affecting investors. In addition, Federal and State transfers grew more than 30% yoy, as variables of the allocation formula such as population growth and own-source revenue collection efficiency have been outstanding.

Expenditure Sustainability: 'Midrange'

Apodaca is responsible for moderate counter-cyclical expenditure mostly maintenance, public security, cleaning and garbage, whose trend has been steep due to the spending pressure stemming from the demographic growth. Apodaca controlled its expenditure growth in 2017-2019, which was reflected in steady and robust operating balances. High net capex was financed with its current balance, cash and debt.

In 2020 the operating balance plunged to 2% of operating revenue because of the pandemic and expenditure inertia. In 2021, as Fitch foresaw, the municipality's operating balance improved, driven by the operating revenue recovery. Notwithstanding, it still remained below pre-pandemic levels (8.2% to operating revenue). With aiming at maintaining a stable financial performance and a high level of cash, Apodaca halved capex.

For 2022, Fitch expects Apodaca's operating balance to strengthen again and reach pre-pandemic levels due to the extraordinary behavior of operating revenues and the expenditure containment (expenses grow in line with the inflation) observed at the first quarter of 2022. Capex would be financed mainly with current balance, maintaining its sound liquidity position.

Expenditure Adjustability: 'Midrange'

Capex has been focused on road infrastructure, paving, rain drainage, street lighting. Apodaca's capex averaged at 23.4% of total expenditure between 2017 and 2021, which indicates a moderate level of investment above the median of the Mexican municipalities rated by Fitch (17.9%). Even though the demographic pressure for public services and infrastructure may make difficult to reduce capex if needed. In 2020 Capex stood moderate with aiming at supporting the local economy and was financed mainly with debt, capital revenue and cash rather than the current balance.

In 2021 Apodaca financed capex only with capital revenue and current balance, which showed its moderate affordability to curb expenses, maintaining its solid liquidity position. The most inflexible costs derive from staff expenditure and public services such as waste collection. Staff expenditure had been rising over the past few years and reached 47.1% of total expenditure in 2021 due to a broader offer of public services, in particular, public security. Since 2021 staff expenditure has been contained and grown slightly below the inflation.

Liabilities & Liquidity Robustness: 'Midrange'

Apodaca's direct debt comprised of two 15-year term bank loans that mature in 2035, with an outstanding balance of MXN400 million at YE 2021. Both loans were taken in 2020 under a municipal global credit line of the state of Nuevo Leon, which was acquired with the National Development Bank (Banobras). Bank loan proceeds were used to refinance three bank loans and for capex. Apodaca improved its debt amortization profile and lowered its interest rate spread after refinancing, which reduced its debt servicing burden. The municipality could borrow up to MXN100 million during 2022 to finance capex if needed. Fitch considers this amount within its debt projections.

Since 2018 Apodaca has Street lighting modernization contract for MXN600 million due 2028. As per criteria, Fitch considers this financial obligation as 'other Fitch-classified debt' as the private took debt in order to buy LED luminaires and property tax was pledged in a trust to cover project payments. The amount of the street lighting modernization contract at YE 2021 was of MX365 million. Servicios de Agua y Drenaje de Monterrey [AAA(mex)] is responsible for water services and therefore does not represent a contingency for the municipality.

Apodaca has a reserve fund to cover pension payments that is financed with contributions from the municipality and its employees. The reserve fund amounts to MXN139 million as of March 2022, while pensions payments reached MXN56.4 million in 2021, or 2.8% of operating expenditure.

Liabilities & Liquidity Flexibility: 'Midrange'

Mexico's framework does not provide emergency liquidity support from upper government tiers. Apodaca's liquidity availability had fallen in 2019 and 2020 due to fiscal deficits; however, its liquidity position remains adequate, as cash can cover financial and commercial current liabilities by more than 1.0x (2020: 1.5x; 2021:1.4x). The Municipality has liquidity available under various forms, notably unrestricted cash. During 2017-2021, the liquidity coverage ratio averaged a high 12.5x the entity's debt service. Apodaca does not have any short-term debt. As of March 2022, Apodaca's cash has increased notably and covers payables around 4x.

Debt Sustainability: 'aa category'

Apodaca's debt sustainability score of 'aa' is the result of a payback ratio score of 'aaa' (below 1.9x in 2022-2026 on average) adjusted one category downwards because of the weaker score of its actual debt service coverage ratio (ADSCR). We expect ADSCR to be below 4x in 2023-2026, with a score of 'aa'. Net adjusted debt remains low, despite higher debt since 2018, resulting in a fiscal debt burden below 50%. Notwithstanding, its unrestricted cash is lower than that of other Mexican municipalities with a debt sustainability score of 'aaa'.

Fitch estimates that in a background of higher interest rates and inflation, the municipality will maintain low debt metrics and adequate operating balance in the 2022-2026 period, averaging 11.6%. Apodaca's direct debt would increase in line with the municipality's capex performance of the last few years.

Derivation Summary

Apodaca's SCP at 'bbb+' reflects a combination of a 'Low Midrange' risk profile and an 'aa' debt sustainability assessment. The SCP also factors in international peer comparison, which includes the City of Brasov (BBB-/Negative) in Romania or the municipality of Zapopan in Mexico (BBB-/Stable).

Apodaca's LT LC IDR is not affected by any other rating factors, but is constrained by the sovereign's IDR due to high revenue dependence and centralized institutional framework for subnationals. Its NLTR is derived from its IDR and also takes into account the municipality's relative position among peers, such as Irapuato (BBB-/Stable), Chihuahua (BBB-/Stable) and Piedras Negras (AAA(mex)/Stable).

National Ratings

Apodaca is comparable with its Mexican peers in the category of 'AAA(mex)', since it has a 'Low Midrange' risk profile, strong debt metrics and its IDR is capped by the sovereign rating. Unlike Mexican municipalities with SCP of 'a', Apodaca has a lower debt sustainability score of 'aa' because its ADSCR is lower in one category.

Key Assumptions

Qualitative assumptions:

Risk Profile: 'Low Midrange'

Revenue Robustness: 'Midrange'

Revenue Adjustability: 'Weaker'

Expenditure Sustainability: 'Midrange'

Expenditure Adjustability: 'Midrange'

Liabilities and Liquidity Robustness: 'Midrange'

Liabilities and Liquidity Flexibility: 'Midrange'

Debt sustainability: 'aa'

Support (Budget Loans): 'N/A'

Support (Ad Hoc): 'N/A'

Asymmetric Risk: 'N/A'

Sovereign Cap: 'BBB-'

Sovereign Floor: 'N/A'

Quantitative assumptions - Issuer Specific

Fitch's rating case is a 'through-the-cycle' scenario, which incorporates a combination of revenue, cost and financial risk stresses. It is based on 2016-2020 figures and 2021-2025 projected ratios. The key assumptions for the scenario include:

Operating revenue CAGR of 7.3% 2021-2026;

Operating expenditure CAGR of 6.9% for 2021-2026;

Variable interest rate (TIIE 28) average of 9.3% for 2022-2026;

Additional long-term debt in 2022 as per the Fiscal Discipline Law of 15% of available operating revenues, which equals to MXN290 million, according to Fitch calculations.

Summary of Financial Adjustments

Fitch's net adjusted debt corresponds to the difference between Fitch-adjusted debt and the local and regional government's unrestricted cash. The latter corresponds to the level of cash at the end of the year, excluding cash that Fitch regards as being earmarked for payables or restricted. The amount of the street lighting modernization contract was considered as other Fitch-classified debt; therefore, it was aggregated in Fitch-adjusted debt.

Issuer Profile

Apodaca is located in the State of Nuevo Leon, at the north of the country. It's also integrated to Monterrey's Metropolitan Area, one of the strongest economic regions in Mexico, and is remarkable because of its industrial and business dynamics. The population growth has been high over the last few years correlated with the municipality's sustained economic growth. As of 2021 the municipality's economy has recovered at a sustained pace, particularly the real estate sector, which contributes significantly to the tax revenues.

Rating Sensitivities

Factors that could, individually or collectively, lead to negative rating action/downgrade:

A negative rating action on the sovereign rating would lead to a downgrade of Apodaca's IDR;

The IDR will be downgraded if the SCP is downgraded due to the debt sustainability score deteriorating to 'a', which would result from a debt payback ratio exceeding 5.0x, coupled with a debt service coverage ratio of below 2.0x, under Fitch's rating case;

The NLTR could be downgraded if the SCP is downgraded to 'bbb- ', which would result from a payback ratio below 5.0x in tandem with an ADSCR consistently below 1.5x under the rating case scenario.

Both of the above-mentioned rating case scenarios could be possible if operating balances will not recover and remain far below their pre-pandemic levels.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

The IDR is constrained by the sovereign rating. Rating action on Mexico's IDR (BBB-/Stable) would lead to corresponding rating action on the issuer. The NLTR is at the highest level, so positive rating action is not possible.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

Sources of Information

The principal sources of information used in the analysis are described in the Applicable Criteria.

Public Ratings with Credit Linkage to other ratings

The ratings of the entity are capped by the sovereign ratings.

Best/Worst Case Rating Scenario

International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

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