Fitch Affirms Durham, NC's Water and Sewer System Revs at 'AAA'; Outlook Stable

Mon Apr 8, 2013 2:35pm EDT

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AUSTIN, Texas--(Business Wire)--
Fitch Ratings affirms the 'AAA' rating on the following bonds issued by the city
of Durham, NC (the city): 

--$73.6 million water and sewer utility system (the system) revenue bonds. 

The Rating Outlook is Stable. 

SECURITY 

The bonds are secured by net revenues of the city's combined water and sewer
utility system (the system). 

KEY RATING DRIVERS 

SOUND FINANCIAL PROFILE: Financial performance of the system is solid, although
debt service coverage and liquidity are projected to diminish over the forecast
period. 

GROWING DEBT BURDEN: Debt levels, which are currently moderate for the rating
category, are projected to increase considerably with the planned issuance of
new debt to fund anticipated system regulatory and maintenance projects. 

STRONG MANAGEMENT PRACTICES: Conservative budgeting and long-term planning
support the system's strong financial results and Fitch's expectation for
continued stability. 

RATE FLEXIBILITY DESPITE INCREASES: Despite recent rate hikes user charges
remain low and well below Fitch's affordability threshold, and provide capacity
for further rate increases likely necessary to support future debt plans. 

STABLE LOCAL ECONOMY: Durham's local economy is growing and diversifying as a
result of the large higher education and healthcare presence and the city's
proximity to Research Triangle Park (RTP). Employment growth exceeds that of the
state and nation, and socio-economic indicators are favorable. 

RATING SENSITIVITY 

DETERIORATION OF FINANCIAL POSITION: In light of significant forthcoming capital
pressures, preservation of liquidity and all-in coverage levels consistent with
Fitch's 'AAA' medians is key to maintaining the rating. 

CREDIT PROFILE 

The combined water and wastewater system serves almost 80,000 customer accounts
within the city of Durham (GO bonds rated 'AAA' by Fitch) and significant
portions of the unincorporated area of Durham County and the RTP. Slightly more
than 90% of system customers reside within the city limits. 

CIP SPENDING COULD PRESSURE FINANCIAL METRICS 

The city's financial profile has been mostly robust over the past five years but
capital expenditures tied to regulatory requirements and system upgrades are
projected to lead to a reduction in annual debt service (ADS) coverage and
liquidity while at the same time contributing to an increased debt load. 

Senior ADS coverage has been strong over the past five years, averaging above
5.0x, although it dropped to a still solid 3.8x in fiscal year (FY) 2012. System
liquidity is also very good, with unrestricted cash of $91.5 million equal to
about 650 days cash in FY 2012. 

Both senior ADS coverage and liquidity metrics are currently above Fitch's 'AAA'
medians. However, all-in ADS coverage, which includes subordinate debt service
on a state revolving fund loan and GO bonds issued by the city on the utility
system's behalf, was marginally weaker reaching lows of 1.6x in both FY 2008 and
FY 2009 and finishing FY 2012 at 1.7x. 

Financial projections provided by management show coverage of all system debt
remaining above 1.5x through FY 2017, although possibly dipping below this level
in FY 2018 due to increased debt costs. Also, as management expects to continue
drawing on its cash reserves for capital projects in order to rely less on debt
issuance, liquidity is forecast to decrease to its required policy minimum of
180 days of cash on hand, which would be noticeably lower than other
similarly-rated utility systems. 

In Fitch's view, in order to maintain the current rating, a liquidity drawdown
of this magnitude would need to be offset with other credit strengths such as
higher all-in ADS coverage. Management notes that its projections typically
consider a conservative, 'worst case' scenario, which historically has been the
case in Fitch's previous reviews of management's forecasts. 

CAPITAL PROJECTS ADD TO DEBT BURDEN 

Extensive and costly system upgrades will be needed going forward in order to
remain compliant with regulatory requirements. Compliance with nutrient
reduction will necessitate a $50 million capital investment to the system's two
wastewater treatment plants over the next five to six years and about $100
million over nine years to upgrade and expand water treatment capacity in order
to comply with tighter rules regarding disinfection byproducts. The costs
related to the capital improvements are built into the system's long-term
capital program. 

Capital spending over the next five years appears aggressive yet manageable,
estimated at $384 million. Approximately 46% of planned spending will be for the
water system, primarily for the aforementioned regulatory projects and system
maintenance. Planned spending for wastewater projects totals $207 million,
mostly for enhanced nitrogen removal and repairs to the collection system.
Overall, planned spending is up by about $26 million compared to the prior
(2011-2015) capital improvement budget. 

Approximately two-thirds of the capital program will be financed by long-term
debt. Accordingly, the city expects to issue an additional $160 million in bonds
in FY's 2015 and 2016. The balance of the capital program will be funded on a
pay-go basis through a sizeable draw down of current cash reserves, excess
operating revenue and impact fees. 

The system's current debt metrics are moderate for the rating category but are
projected to more than double through FY 2018 to fund the previously discussed
capital projects. However, Fitch believes that some of the projected debt
increases may not fully materialize due in part to management's conservative
budgeting practices and its ability to delay projects, if necessary. 

AMPLE RATE FLEXIBILITY REMAINS 

Based on Fitch's assumption of 7,500 gallons per month of consumption, the
combined utility rate in FY 2012 was approximately $75 or 1.9% of median
household income (MHI). However, actual customer bills as reported by the city
were lower, averaging $50 monthly or about 1.3% of MHI. This is comfortably
below Fitch's affordability threshold of 2% of MHI, leaving ample rate
flexibility to meet rising debt obligations. 

EXCESS WATER SYSTEM CAPACITY 

The system benefits from an ample long-term raw water supply, derived primarily
from Lake Michie, which is supplied by the Flat River, and the Little River
Reservoir. The city also maintains contractual agreements with seven neighboring
cities for additional supply through existing interconnections if needed. Both
current water supply and treatment capacity at the system's two water treatment
plants are more than double the FY 2012 demand of 22 million gallons daily. The
wastewater system provides collection, treatment and disposal service and
operates two treatment facilities with ample capacity for the foreseeable
future. 

STABLE AND DIVERSE LOCAL ECONOMY 

Durham, the fourth largest city in the state of North Carolina, is considered
part of the 'Triangle' consisting of Raleigh, Durham and Chapel Hill. Located
approximately 25 miles from Raleigh, the state capital, Durham plays an integral
role in an economically diverse region anchored by RTP and Duke University. The
city's unemployment rate of 6.7% in November 2012 ranked below the broader
county and Durham-Chapel Hill MSA and was noticeably lower than the state
figure. Income levels also exceed that of the state, but have remained just
below national figures. 

Additional information is available at 'www.fitchratings.com'. The ratings above
were solicited by, or on behalf of, the issuer, and therefore, Fitch has been
compensated for the provision of the ratings. 

Applicable Criteria and Related Research: 

--'Revenue-Supported Rating Criteria' (June 12, 2012); 

--'U.S. Water and Sewer Revenue Bond Rating Criteria' (Aug. 3, 2012); 

--'2013 Water and Sewer Medians' (Dec. 5, 2012); 

--'2013 Outlook: Water and Sewer' (Dec. 5, 2012). 

Applicable Criteria and Related Research 

Revenue-Supported Rating Criteria 

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=681015

U.S. Water and Sewer Revenue Bond Rating Criteria 

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=684901

2013 Water and Sewer Medians 

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=695756

2013 Outlook: Water and Sewer Sector 

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=695755

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.

Fitch Ratings
Primary Analyst
Major Parkhurst, +1-512-215-3724
Director
Fitch Ratings, Inc.
111 Congress Avenue,
Austin, TX 78701
or
Secondary Analyst
Julie Seebach, +1-512-215-3731
Director
or
Committee Chairperson
Michael Rinaldi, +1-212-908-0833
Senior Director
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Copyright Business Wire 2013

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