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) was downgraded to 'bbb' from 'bbb+'. 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 the Municipality of Apodaca's debt-sustainability metrics will remain satisfactory with a stable risk profile over a five-year rating horizon (2023-2027) based on its good historical financial performance supported by its dynamic economy. Apodaca sustains strong revenue growth prospects for the coming years and significant levels of unrestricted cash despite the noticeable impact of the pandemic on Apodaca's public finances in 2020. Even though operating balances showed a positive trend in 2021-2022, these have not recovered to their pre-pandemic levels. For this reason, Fitch expects actual debt service coverage ratio (ADSCR) to be weaker aligned with Mexican municipalities with a SCP of 'bbb' such as Irapuato.

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'

This KRF is assessed as 'Midrange' for Apodaca because the operating revenue is closely related to the performance of the national transfers, coming from the sovereign rated 'BBB-', as they have stood for more than half of such 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 2018-2022 period the growth rate of Apodaca's operating revenue was higher than the real national GDP growth (the operating revenue CAGR in real terms was 5% compared with GDP CAGR of --0.22%), except in 2020 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 69.3% of Apodaca's operating revenue in 2018-2022.

Since 2021 own-source revenues have recovered after the impact of the pandemic, supported by the municipality's economic structure, which is linked to the U.S. economy. However, transfers performance has been fluctuating. For 2022, operating revenue soared by 18.7% due to a higher local revenue collection related to the economic recovery as well as a larger amount of federal transfers received, which are allocated according to defined formulas. In 2023, own-source revenues growth prospects continue to be positive, but federal transfers have stagnated due to the fall of the Shared Federal collection.

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's own-source revenues performance has been remarkable due to collection strategies coupled with the strong economic growth (new industrial and housing developments). The most important strategies implemented by the municipality are the collection management program through a specialized firm to recover past-due portfolios of the property tax, the reduction of fiscal benefits and the cadastral updating. In 2022, tax revenue increased by 14.3% and federal and state transfers grew around 23% yoy, as variables of the allocation formula such as population growth and own-source revenue collection efficiency were outstanding.

As of March 2023, tax revenue decreased slightly due to real-estate transfer tax behavior, which dipped by MXN30 million. This latter was driven by extraordinary operations received at 1Q22. On the other hand, the state of Nuevo Leon created a new fund for some of its municipalities. Apodaca will receive MXN 351.6 million for capex and public safety (opex).

Expenditure Sustainability: 'Midrange'

Apodaca is responsible for moderate counter-cyclical expenditure mostly maintenance, public security, waste collection, whose trend has been significant due to the spending pressure stemming from the demographic growth. Despite this, over the period 2018-2022 Apodaca's expenditure trajectory has been controlled and predictable. During 2018-2022 opex growth (CAGR of 9%) was higher than operating revenue growth (CAGR of 5%) influenced significantly by the sharp plunge of operating revenue in 2020 derived from the extraordinary effect of the pandemic.

After reaching a minimum in 2020, operating balances have recovered steadily in 2021-2022, driven by the operating revenue recovery linked to the ongoing economic growth. Notwithstanding, they still remained below pre-pandemic levels (10.1% vs 20.4% in 2018-2019). In 2022 opex grew by 16% triggered by the reactivation of some municipal activities (mainly maintenance and social events) stopped since 2020 due to the pandemic lockdown and a higher demand of public services relating to population growth (social supports, public security and waste collection). In addition, the municipality had an extraordinary spending related to water supply due to the drought experienced in the Monterrey metropolitan area.

In 2020-2022 Apodaca's operating margins were weaker than the median of Mexican municipalities rated by Fitch and the threshold established by the agency to assess this KRF of 12%. Hence, Fitch will monitor the operating balance behavior, as in the event that the operating margin continues below the threshold, this KRF could be revaluated to weaker.

Expenditure Adjustability: 'Midrange'

Capex has been focused on road infrastructure, paving, rain drainage and street lighting. Apodaca's capex averaged 21.4% of total expenditure between 2018 and 2022, which indicates a moderate level of investment above the median of the Mexican municipalities rated by Fitch (17%). In 2021 and 2022 Apodaca financed capex only with capital revenue and current balance, which showed certain affordability to curb expenses, maintaining its solid liquidity position.

The most inflexible costs derive from staff expenditure and public services such as waste collection and public security. Staff expenditure had been rising over the past few years 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 rate and reached 42.6% of total expenditure in 2022. However, in 2021 and 2022 the capex ratio was lower than 15%, below the median of Mexican municipalities rated by Fitch. Therefore, if this metric continues below such a median structurally, this KRF could be reassessed to weaker.

For 2023, the municipality budgeted MXN453.2 million for capex, which would be an increase of 35.1% yoy. This amount would be financed with capital revenues (mostly from the State), current balance and bank loan proceeds. This could allow the capex ratio to reach around 20%, above the median mentioned.

Liabilities & Liquidity Robustness: 'Midrange'

At YE 2022 Apodaca's direct debt was comprised of two 15-year term bank loans that mature in 2035, with an outstanding balance of MXN389.5 million. Both loans were taken in 2020 under a municipal global credit line of the state of Nuevo Leon [AA+(mex)vra], which was acquired with the National Development Bank (Banobras). Bank loan proceeds were used to refinance three credits and for capex. Apodaca improved its debt amortization profile and lowered its interest rate spread after refinancing, which reduced its debt servicing burden.

In December 2022 the municipality contracted a new 15-year term bank loan for MXN100 million also under the municipal global credit line. Such credit has been disposed in 2023 and assigned to finance road infrastructure. 35% of its federal revenue sharing were pledged in a special purpose vehicle to cover the debt servicing of these three bank loans. The total outstanding debt balance was of MXN485.7 million at 1Q23. For 2023 Apodaca will take additional debt for MXN65 million to fund new road infrastructure. Fitch considers these amounts 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 2022 was of MXN305 million. Servicios de Agua y Drenaje de Monterrey (AA+[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 MXN170.6 million as of March 2023, while pensions payments reached MXN66.8 million in 2022, or 2.9% 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 remained adequate, as cash can cover financial and commercial current liabilities by more than 1.0x. In 2022 the cash amounted to MXN440 million and the current liabilities dropped, so the liquidity metric improved to 2.0x from 1.4x in 2021 derived from the surplus recorded. The municipality has liquidity available under various forms, notably unrestricted cash. During 2020-2022, the liquidity coverage ratio averaged a high 10x the entity's debt service. Apodaca does not have any short-term debt.

Debt Sustainability: 'aa category'

Apodaca's debt sustainability score of 'aa' is the result of a payback ratio score of 'aaa' (below 2x in 2023-2027 on average) adjusted one category downward because of the weaker score of its ADSCR. We expect ADSCR to be between 2x and 4x in 2025-2027, with a score of 'aa'. Net adjusted debt remains low, despite new borrowings in 2020 and 2023. Regardless, 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 high interest rates and inflation, the municipality will maintain low debt metrics and adequate operating balance in the 2023-2027 period, averaging 9.7%. 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-/Stable) in Romania or the municipality of Yumbo in Colombia. Its 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 considers the municipality's relative position among peers, such as Tlalnepantla or Celaya.

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 an SCP of 'a', Apodaca has a lower debt sustainability score of 'aa' because its ADSCR is lower in one category.

Key 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 (LT IDR): '-'

Sovereign Cap (LT LC IDR) '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 2018-2022 figures and 2023-2027 projected ratios. The key assumptions for the scenario include:

Operating Revenue CAGR of 7.5% for 2022-2027;

Operating expenditure CAGR of 8.2% for 2022-2027;

Variable Interest rate (TIIE 28) average of 11.8% for 2023-2027;

Adjusted debt considers additional debt authorized for the 2023 budget (MXN65 million) and the acquired in December 2022 (MXN100 million); and assumes new debt in 2024 equals to 15% of ILD or MXN338 million, as per Fitch calculations.

Issuer Profile

Fitch classifies Apodaca as a Type B local and regional government (LRG), similar to all Mexican LRGs, as it covers annual debt service from cash flow. 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 in the last ten years.

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

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.

References for Substantially Material Source Cited as Key Driver Rating

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

RATING ACTIONS

Entity / Debt

Rating

Prior

Apodaca, Municipality of

LC LT IDR

BBB-

Affirmed

BBB-

Natl LT

AAA(mex)

Affirmed

AAA(mex)

Page

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VIEW ADDITIONAL RATING DETAILS

Additional information is available on www.fitchratings.com

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