News Column

Fitch Affirms Orange Water and Sewer Authority, NC Revs at 'AA+'; Outlook Stable

July 24, 2014

AUSTIN, Texas--(BUSINESS WIRE)-- Fitch Ratings affirms its 'AA+' long-term rating on the following Orange Water and Sewer Authority (OWASA or the authority), North Carolina revenues bonds:

--$42.1 million outstanding water and sewer revenues refunding bonds, series 2010, 2005 and 2003 ;

--$19.8 million outstanding water and sewer revenue bonds, series 2006. ;

--$20 million outstanding variable rate water and sewer revenue bonds, series 2004B.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by a senior lien pledge of the net revenues of the authority's water and sewer system. Each issue has a separately secured debt service reserve fund except the series 2010 bonds.

KEY RATING DRIVERS

STRONG FINANCIAL PROFILE: System financial performance has improved over the past several years, due primarily to large rate increases implemented between 2008 and 2011 that have boosted debt service coverage to 2x or more for the last four fiscal years and increased liquidity to more than 400 days of cash on hand.

RATE HIKES DAMPEN FLEXIBILITY: User bills are above average compared to surrounding communities, but still fall below Fitch's affordability threshold. While rate raising flexibility may be shrinking, future rate adjustments are expected to be modest and track inflationary increases.

SOLID SERVICE AREA ECONOMY: The service area benefits from the presence of the University of North Carolina, Chapel Hill (the university), and its proximity to the growing Research Triangle Park and the state capital of Raleigh.

AVERAGE DEBT BURDEN: The system's debt per customer of $2,091 is only slightly elevated compared to the 'AA' rating category average of $1,812. Fitch expects debt will decline over time with a manageable and mostly pay-go funded capital plan and rapid retirement of existing debt.

MANAGEABLE CAPITAL NEEDS: Ample water supply and significant excess treatment capacity help keep capital needs manageable.

RATING SENSITIVITY

STABILITY EXPECTED: The rating is sensitive to fluctuations in various credit fundamentals including financial and operating performance, capital needs and debt levels. The Stable Outlook reflects Fitch's opinion that such changes are not anticipated at this time.

CREDIT PROFILE

The authority operates in southeastern Orange County (general obligation bonds rated 'AAA', Outlook Stable by Fitch), about 10 miles southwest of Durham and 25 miles northwest of Raleigh. The service area includes the towns of Chapel Hill and Carrboro, and serves an estimated population of 80,000 (most of whom reside in Chapel Hill).

STRONG SERVICE AREA CHARACTERISTICS

The service area benefits considerably from the presence of the university (rated 'AAA', Outlook Stable by Fitch) and its proximity to the Research Triangle Park and Raleigh. The university remains the state's flagship school and anchor to the region's employment base. The university's fall 2013 enrollment exceeded 26,000.

The city and county's unemployment rate is favorable at 4.9% as of May 2014, below that of the Durham metropolitan statistical area (5.3%), the state (6.6%) and the nation (6.1%). Chapel Hill's income levels are 29% and 13% above the state and national averages, respectively.

The authority serves approximately 21,000 water and sewer customers. The customer base is mostly residential and stable; however, more than 22% of water sales in 2013 were derived from the university, which remains the single largest customer. This large customer concentration is offset by the university's importance within the state higher education system and its role as a large regional employer. In addition, no other user accounts for more than 1% of system sales.

AMPLE SYSTEM CAPACITY LIMITS FUTURE CAPITAL NEEDS

OWASA's raw water supply is drawn from two surface reservoirs and University Lake, and is reportedly sufficient to meet projected demand for at least the next 30 years. For emergency purposes, the authority also maintains an allocation from Jordan Lake and has supplementary finished water connections to other neighboring utilities.

Treatment capacity at the authority's water treatment facility totals 20 million gallons per day (mgd), which is well in excess of the 6.6 mgd average daily demand. There is also significant capacity at OWASA's wastewater treatment plant, with design capacity at roughly 2x the current average daily flow. With minimal growth projected and ample supply and treatment capacity, the authority's capital needs through 2019 total a modest $75 million. The program is expected to be largely cash funded with a possible issuance of approximately $20 million in 2018.

SOLID FINANCIAL RESULTS AIDED BY RATE INCREASES

Despite ongoing declines in consumption that have persisted over the past decade, OWASA's financial performance trends remain strong. Severe drought conditions in 2002 and again in 2007 through 2008, coupled with the implementation of a conservation-based rate structure and the use of reclaimed water, led to a significant drop in demand of about 30% from 2002 to present. The corresponding decline in operating revenues prompted the implementation of sizeable rate hikes to boost operating margins and increase debt service coverage.

Coverage since 2010 has consistently registered at or above 2x. Management forecasts, which appear reasonable and relatively conservative, indicate continued coverage of 1.8x-2.2x through fiscal 2019. Unrestricted cash and equivalents also has improved and for fiscal 2013 was over $25 million, providing a sizable cushion of more than 400 days of operations. The projections include conservative estimates for future energy, chemical and health insurance costs, while anticipating inflationary rate adjustments for approximately 3%. A modest amount of debt, $20 million, is anticipated for the forecast period as well.

RATES ARE RELATIVELY HIGH

Water and sewer rates cumulatively have gone up by 42% and 47%, respectively, between fiscal 2007 and 2013. The average monthly residential bill for combined service is a somewhat high $110 or about 2.6% of median household income (MHI), assuming an industry monthly consumption average of 7,500 gallons. According to the authority, demand for the average residential user continues to decline and now is closer to 4,000 gallons per month. This low monthly consumption results in a more affordable monthly bill of about $70 or 1.5% of MHI. Rate increases going forward are expected to be a very reasonable 3% annually to keep pace with inflation.

AVERAGE DEBT BURDEN TO IMPROVE

The debt burden is adequate for the rating category with debt per customer of $2,091, only slightly higher than the 'AA' median of $1,812. Total debt outstanding as of fiscal end 2013 of $85 million is a moderate 30% of net assets and a manageable 23% of gross revenues. Approximately 20% of the system debt profile is made up of unhedged variable rate bonds; Fitch considers this level of VRDO exposure manageable. Debt ratios are projected to improve over the next several years given the rapid pay-out of existing debt (61% retired in 10 years and 100% retired in 20 years) and manageable capital program.

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

In addition to the sources of information identified in the U.S. Municipal Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope and UNC Environmental Finance Center.

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:

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

Revenue-Supported Rating Criteria

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

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=841469

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

Teri Wenck, CPA

Associate Director

+1 512-215-3742

Fitch Ratings, Inc.

111 Congress Avenue,

Austin, TX 78701

or

Secondary Analyst

Andrew DeStefano

Director

+1 212-908-0284

or

Committee Chairperson

Steve Murray

Senior Director

+1 512-215-3729

or

Media Relations, New York

Elizabeth Fogerty, +1 212-908-0526

elizabeth.fogerty@fitchratings.com

Source: Fitch Ratings


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