Fitch Rates Winston-Salem, NC's Water & Sewer Revs 'AA+'; Outlook Stable

Fitch Ratings assigns an 'AA+' to the following Winston-Salem, NC (the city) revenue bonds:

--Approximately $33 million water and sewer system revenue refunding bonds, series 2014A;

--Approximately $15 million taxable water and sewer system revenue refunding bonds, series 2014B.

The bonds are expected to sell via negotiation on Nov. 12. Bond proceeds will be used to refund the outstanding series 2005 bonds for interest savings and pay issuance costs. Savings are expected to be taken annually with no extension of maturities.

In addition, Fitch affirms the ratings on the following outstanding revenue bonds of the city:

--Approximately $460 million in outstanding water and sewer system revenue bonds at 'AA+'.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by a senior lien pledge of the net revenues of the water and sewer system (the system). Revenues include rates, rentals, fees and other income associated with the ownership and operation of the system, but specifically excludes investment income.

KEY RATING DRIVERS

STRONG FINANCIAL FLEXIBILITY: The system's strong balance sheet resources and affordable rates provide significant flexibility to meet the expected rise in debt carrying charges while helping to offset the historically below average debt service coverage (DSC) margins and free cash flow (FCF).

STRONG SYSTEM CAPACITY: Prudent long-term capital planning has led to abundant water supply and ample system capacity to meet the city's long-term needs. Near-term capital needs are manageable, focusing on sewer improvements and overall system repair and rehabilitation.

REGIONAL ECONOMIC CENTER: The system is part of the growing 12-county Piedmont-Triad region of North Carolina. The city has become a regional hub for health care, higher education, and biotechnology, having diversified from its traditional concentration in manufacturing.

ELEVATED DEBT BURDEN: Debt ratios are elevated compared to similarly-rated systems. Expectations for additional debt coupled with slow amortization of existing bonds will keep the debt burden high for the foreseeable future.

RATING SENSITIVITIES

FINANCIAL FLEXIBILITY AND DEBT PROFILE CHANGES: The rating is sensitive to shifts in financial metrics, including liquidity levels and DSC, and debt. A significant decline in financial ratios or rise in debt beyond current expectations could lead to downward pressure on the ratings.

CREDIT PROFILE

REGIONAL SERVICE PROVIDER WITH SOLID ECONOMIC UNDERPINNINGS

The system has transitioned into a regional water and sewer provider, serving the city, several nearby incorporated towns and villages, and most of the unincorporated areas of Forsyth County. Retail service is provided to a growing and mostly residential retail customer base of roughly 115,000 water and 88,000 sewer accounts. The system's largest 10 users, which include a relatively small amount of wholesale service to several nearby utilities, are relatively diverse, accounting for 15% of total revenue in fiscal 2014. Reynolds American, Inc. is atop the leading customer list, comprising 5% of total revenues.

Forsyth County is a major economic center for northwestern North Carolina, and its principal commercial, retail, and service anchor is Winston-Salem (both the city's and the county's general obligation bonds are rated 'AAA', Outlook Stable by Fitch). Growth in healthcare and higher education has helped diversify the economy, although manufacturing still plays an important role in the employment base. Due to a combination of employment growth and slight decline in the labor force the unemployment rate for the Winston-Salem metropolitan statistical area has declined to 6.5% in July 2014 from 9.4% two years prior.

STRONG CAPITAL PLANNING AND ASSET MANAGEMENT

Significant capital spending has led to an elevated debt burden but also produced ample resources and strong water and sewer treatment capacity. The system also benefits from an abundant water supply from both the Yadkin River and Salem Lake, with the Yadkin River alone capable of supplying all of the area's needs for the foreseeable future. The city owns and operates three water treatment plants that have a combined rated capacity to treat up to 91 million gallons per day (mgd). Annual water treated in fiscal 2014 totaled 36 mgd, leaving the system with significant excess treatment capacity to serve the residents over the long term. Sanitary sewer treatment is provided by two wastewater treatment plants, with combined capacity of 51 mgd. Average flows totaled almost 31 mgd in 2013, or roughly 60% of total capacity.

STRONG FINANCIAL FLEXIBILTY

The system's financial position remains strong with notably high cash balances offsetting below average FCF and DSC. Pledged revenues, which exclude investment income but incorporate growth-related conveyance fees, covered annual debt service on senior and subordinate lien obligations by 1.4x in fiscal 2013. FCF, which measures the amount of cash flow available for capital spending after annual payments for operations and debt service, is notably low at 44% of depreciation on average over the past five years. While DSC and FCF are low for the rating, the system's exceptionally strong cash position provides ample cushion.

The system ended fiscal 2013 with over $62 million in unrestricted cash and investments, which is equivalent to 600 days cash on hand (DCOH). When including renewal and replacement fund balances ($37 million), DCOH is over 960 days. Even when adjusted for potential swap termination, total liquidity is well in excess of both the city's prudent reserve policy that requires one year of operating expenses on hand and Fitch's median for 'AAA'-rated systems (671 days). Fitch believes exceptional liquidity partially mitigates continued concern regarding an above average equity portfolio and the below average projected DSC and FCF.

Fiscal 2014 results are preliminary and unaudited, but show a decline in DSC despite a rate increase due to a combination of slightly lower total revenues, a slight increase in operating and maintenance costs, and ascending annual debt service (ADS).

An increase in both unrestricted cash and equivalents and renewal and replacement fund balances in fiscal 2014 further improves liquidity to more than 1,000 DCOH (839 days when adjusting for swap exposure).

Financial projections provided by the city include annual rate increases ranging between 5%-7%, which is similar to previous forecasts, and all-in ADS coverage of 1.2x-1.3x through fiscal 2019. The forecast does not include the potential interest cost savings from the issuance of the 2014A and 2014B bonds.

Growth in customer accounts has historically helped keep user charges low. Even after boosting water rates by more than 50% and sewer rates by more than 60% since fiscal 2008, the average monthly combined bill of $51 for 6,000 gallons is less than other regional providers and amounts to an affordable 1.5% of median household income.

MODERATE CAPITAL NEEDS, DEBT TO REMAIN ELEVATED

As growth in the service area has slowed in recent years, the system's long-term capital needs have begun to moderate. The system's five-year capital improvement plan (CIP) through 2019 totals $255 million and focuses on upgrades to treatment facilities and pump stations and the overall repair and rehabilitation of system assets. Funding sources include prior bond proceeds, additional bonds totaling $95 million and state revolving fund subordinate lien loans. The city anticipates issuing approximately $50 million in parity revenue bonds in late 2015. Pay-go sources are expected to be $10 million-$20 million annually, or about 27% of total resources.

Fitch expects the system's debt levels to remain elevated for the foreseeable future as anticipated issuances over the next few years will outpace existing principal retirement. In fiscal 2014, outstanding debt measured a still elevated but better $1,231 per capita and 64% of the value of system's net fixed assets. Fitch believes the system's exposure to hedged variable rate debt (equal to about 28% of total debt outstanding) is manageable despite a large negative swap valuation of $20 million as of June 30, 2014, given sizeable cash reserves.

Liquidity support for all three series of variable rate demand bonds (series 2002B, 2002C, and 2007B) is provided by a single bank - BB&T (long-term Issuer Default Rating of 'A+' with a Stable Outlook by Fitch). The liquidity facilities expire in March 2015. While the city was successful in securing the liquidity support after all three previous facilities expired in 2012, dependence on a single entity for liquidity presents a moderate level of risk if the bank's credit quality deteriorates. The city expects to begin the process of requesting bids from liquidity providers within the next 90 days. Given the high ratings and solid credit fundamentals, Fitch assumes the city will continue to garner market support for such products.

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

In addition to the sources of information identified in Fitch's Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope.

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria' (June 2014);

--'U.S. Water and Sewer Revenue Bond Rating Criteria' (July 2013);

--'2014 Water and Sewer Medians' (December 2013);

--'2014 Outlook: Water and Sewer Sector' (December 2013).

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

U.S. Water and Sewer Revenue Bond Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715275

2014 Water and Sewer Medians

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724358

2014 Outlook: Water and Sewer Sector

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724357

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=913154

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.