Sept 28 - Fitch Ratings takes the following action on Winston-Salem, North Carolina (the city): --Approximately $500 million water and sewer system revenue bonds affirmed 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 SOLID FINANCIAL FLEXIBILITY: The system's strong balance sheet resources and affordable rates provides significant flexibility to meet rising debt carrying charges, while helping to offset the historically below average debt service coverage margins. STRONG SYSTEM CAPACITY: Sound long-term capital planning has provided abundant water supply and ample water and sewer treatment capacity. As a result, near-term capital needs are manageable and will focus on 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. ABOVE AVERAGE DEBT BURDEN: The system has over $500 million in debt outstanding. Debt ratios are above average compared to similarly-rated systems, and slow amortization coupled with the expectation for additional bonds will keep the debt burden high for the foreseeable future. WHAT COULD TRIGGER A RATING ACTION SIGNIFICANT DECLINE in LIQUIDITY: Maintaining strong liquidity levels is key to guarding against a somewhat aggressive investment portfolio, and helps offset the historical and projected below average debt service coverage margins. SIGNIFICANT INCREASE IN DEBT: Rates are expected to rise over the next five years to meet the already high debt carrying charges and expected issuance of additional bonds. Fitch believes an appreciably higher debt burden could lead to even higher rates than currently forecasted (leading to lower rate affordability), while putting further stress on financial performance. 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 123,000 water and 94,000 sewer accounts. The system's largest 10 users are relatively diverse and accounted for 11% of total revenue in fiscal 2011. The system also provides wholesale service to several nearby public utilities. 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. The unemployment rate for the Winston-Salem metropolitan statistical area remains somewhat elevated at 9.4% as of July 2012. STRONG CAPITAL PLANNING AND ASSET MANAGEMENT ARE CREDIT STRENGTHS The system benefits from an abundant water supply from both the Yadkin River and Salem Lake, although the Yadkin River alone is capable of supplying all of the area's needs for the foreseeable future. Treatment capacity is also strong. 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 demand in 2011 of 37 mgd leaves the system with significant excess treatment capacity. Sanitary sewer treatment is provided by two wastewater treatment plants, with combined capacity of 51 mgd. Average flows totalled almost 31 mgd in 2011, or roughly 60% of total capacity. FINANCIAL FLEXIBILTY REMAINS STRONG The system's financial position remains strong with notably high cash balances offsetting below average debt service coverage. Pledged revenues, which exclude investment income but incorporate growth-related conveyance fees, covered annual debt service (ADS) on senior lien obligations by 1.5 times (x) in fiscal 2011, and all-in ADS by slightly less than 1.5x. Including the 12% of liquid assets permitted by the bond indenture, all-in debt service coverage rises to a solid 1.9x. While ADS coverage is low for the rating, the system's exceptionally strong cash position provides ample cushion. With over 950 days of cash on hand, the system ended fiscal 2011 with very strong liquidity that is well in excess of its prudent reserve policy requiring one year of operating expenses on hand. The system's strong liquidity position partially mitigates Fitch's continued concern regarding an above average equity portfolio and the below average projected debt service coverage. Fiscal 2012 results are preliminary and unaudited, but show a decline in debt service coverage despite a rate increase due to ascending ADS. Financial projections provided by the city include annual rate increases ranging between 7%-9%, which is similar to previous forecasts, and all-in ADS coverage of 1.2x-1.4x through fiscal 2017. Significant growth in customer accounts over the years has helped keep user charges low. Even after boosting water rates by 37% and sewer rates by 47% from fiscal 2008 through fiscal 2012, the average monthly combined bill of $48 for 6,000 gallons is less than other regional providers and amounts to an affordable 1.4% of median household income. CAPITAL NEEDS ARE MODERATE, 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 six-year capital improvement plan (CIP) totals $262 million and focuses primarily on upgrades to its treatment facilities and pump stations and the overall repair and rehabilitation of system assets. Funding sources include existing 2010 bond proceeds and additional bonds of approximately $140 million. Pay-go sources are expected to be roughly $10 million annually, or about 23% of total resources. Fitch expects the system's elevated debt levels to remain high for the foreseeable future given the slow pay-out of existing bonds (just 38% retired in 10 years) and anticipated issuances in 2015 and 2017. Outstanding debt measured on a per capita basis totals approximately $1,500, and equals about 75% of the value of system assets. Fitch believes the system's exposure to hedged variable rate debt (equal to about 27% of total debt outstanding) is manageable despite a large negative swap valuation of $31 million as of June 30, 2012, 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+' and Stable Outlook by Fitch). The liquidity facilities expire in March 2015, and while the city was successful in securing the liquidity support after all three previous facilities were set to expire in 2012, dependence on a single entity for liquidity presents a moderate level of risk if the bank's credit quality deteriorates.