NEW YORK--(BUSINESS WIRE)--Fitch Ratings assigns an 'AAA' rating to the following Charlotte, NC (the city) revenue bonds:
--Approximately $466 million water and sewer revenue refunding bonds series 2015.
The bonds are expected to sell via negotiated sale the week of August 10.
Proceeds will be used to refund the city's variable rate bonds series 2002B and series 2002C and the related costs incurred in connection with the termination of the interest rate swap agreements between the city and Bank of America, N.A.; to refund the series 2005A bonds maturing on and after Dec. 1, 2016 and series 2006A bonds maturing on and after July 1, 2017; to prepay in full the city's revenue bond anticipation note, Series 2014; and to pay issuance costs.
In addition, Fitch affirms the following outstanding ratings:
--Approximately $1.3 billion combined water and sewer system revenue bonds (prior to the refunding) at 'AAA'.
The Rating Outlook is Stable.
SECURITY
The bonds are payable from a senior lien pledge of the net revenues of the water and sewer system (the system), including connection fees.
KEY RATING DRIVERS
STABLE FINANCIAL HISTORY: General financial results have been very stable over time and unrestricted cash levels robust, tempering risk associated with low debt service coverage (DSC) relative to the 'AAA' median. Additional rate increases planned by management and expectations for continued economic growth is likely to sustain incremental improvement in financial metrics.
ELEVATED DEBT BURDEN: Debt levels are elevated compared to similarly rated systems, and debt carrying charges consume a high proportion of gross operating revenue. Fitch expects debt to remain elevated but fairly stable, based on reported issuance plans and projections for continued customer growth.
STRONG ECONOMIC PROFILE: The city's role as a regional economic center for trade, transportation, health care, financial services and other sectors continues to grow and expand. Income indices are above average and unemployment rates are below average, reflecting strong capacity for repayment of system operating and debt needs.
GROWTH DRIVES INCREASED CAPITAL PROGRAM: The system's five-year capital improvement program (CIP) has increased in recent years in order to accommodate a resurgence in economic growth and expansion as well as to continue investment in renewal and replacement (R&R) of existing infrastructure. Importantly, capital needs are not driven by capacity restraints or regulatory compliance, affording some greater discretion in its execution over time.
RATING SENSITIVITIES
REALIZATION OF FINANCIAL PROJECTIONS: Management's ability to meet or exceed its financial forecast will be important to maintain rating stability. As the forecasted financial and debt results are still considered weak relative to Fitch's 'AAA' rating category, a departure from the current debt, capital and rate plans and a concurrent decline in the system's robust liquidity levels could potentially exert downward pressure on the rating.
CREDIT PROFILE
HIGH BUT STABLE DEBT FORECASTED
System debt levels are considered high and historically have resulted in elevated debt ratios and low DSC levels relative to Fitch's 'AAA' rating category. Outstanding debt consists of $1.3 billion in parity revenue bonds and $189 million in general obligation (GO) bonds issued by the city on behalf of the utility. These levels equate to 52% of net assets -- double that of the 'AAA' median -- and debt per customer amounts nearly three times the rating category median. Annual debt service (ADS) consumes an elevated 45% of gross operating revenues, also nearly three times the median average.
Management intends to issue approximately $294 million over the next five years through the issuances of short-term notes every two years through at least 2023 (given market conditions) to support capital needs. Despite this new debt, Fitch's model indicates that the combination of existing principal amortization and steady customer growth result in a continued moderate decline in the debt metrics through the forecast.
STABLE OPERATING RESULTS
The consistently high debt levels have led to objectively low, but very stable, financial results relative to similarly-rated credits. Senior and all-in DSC averaged 2.0x and 1.4x, respectively from fiscal 2010 to fiscal 2014 compared to the 'AAA' medians are 4.4x and 2.8x, respectively. Fiscal 2014 net revenues yielded 2.1x senior lien DSC and unaudited fiscal 2015 results show DSC improving to 2.2x. All-in DSC, including annual debt service (ADS) related to GO debt issued for the system, subordinate to the system's revenue bonds, was 1.5x in fiscal 2014 and an unaudited 1.6x in fiscal 2015.
Management's financial forecast predicts flat senior lien DSC between 2.0x and 2.1x through fiscal 2020 as new debt rolls on. All-in DSC is shown to improve to 1.8x by fiscal 2020 as the subordinate lien debt amortizes and no additional GO debt is issued on the system's behalf.
AMPLE RATE-SETTING FLEXIBILITY
The forecast incorporates 4% annual rate increases and assumes 0.5% annual customer growth (more recent growth has approximated 2% annually). The average water/sewer customer charge of roughly $57 equates to a low 1.4% of median household income (MHI), well below Fitch's 2.0% affordability threshold. These charges are inclusive of a fixed availability fee first implemented in 2012 to recover 20% of the system's annual principal debt payment. The fee has since been increased to 25% and management plans to increase it to as high as 40% over time. The system's rates are not only affordable per customer but are comparatively lower than surrounding systems. This affords management ample rate-raising flexibility in order to realize its financial forecast as it has done historically.
ROBUST LIQUIDITY SUPPORTS RATING
Fitch maintains that the system's strong cash position and ample rate-setting flexibility mitigates and offsets its relatively low DSC levels and higher leverage. Since 2010 unrestricted cash balances have averaged over two years' worth of cash on hand, and in fiscal 2014 the system's $193.7 million in cash equated to a robust 659 days (the 'AAA' median is 481 days).
These balances were maintained despite the system's primary use of pay-go for capital spending. Financial projections predict that unrestricted cash will stay strong through fiscal 2020 with an average of $154 million in unrestricted cash maintained, equating to 435 days cash on hand. These projections also show cash levels remaining well above management's policy of a fund balance equal to or above 35% of annual operating expenditures and debt service; cash will instead range between 52% - 61% of expenditures through fiscal 2020. The rating anticipates that the system will sustain the trend of strong cash balances as forecasted, inclusive of substantial pay-go spending.
INCREASED CAPITAL NEEDS TO SUPPORT GROWTH
The size and scope of the current CIP has increased since Fitch's last review as economic and residential growth has rebounded. The 2016 - 2020 CIP, inclusive of capital spending amounts appropriated during prior CIP authorization cycles, totals $845 million, a roughly 21% increase over the prior comparable capital plan of roughly $696 million for fiscals 2015-2019. The current CIP is expected to be 35% debt-funded with the remaining paid for by pay-go.
In addition to growth, management attributes the rise in capital needs to the re-scheduling of several discreet projects that had been deferred during the service area's economic contraction during the late 2000's. Much of the CIP, as previously reported, still supports substantial renewal and replacement projects. Notably, the system does not face any mandatory or regulatory-driven capital requirements, affording the system considerable flexibility to defer non-urgent projects as needed.
MINIMIZATION OF VARIABLE RATE DEBT CREDIT POSITIVE
Prior to this refunding the system had nearly $400 million or about 27% of the system's total debt in variable rate mode. The current sale will refund two of the three variable rate bonds, leaving approximately $162 million in variable rate debt outstanding, or a more moderate 13% of the total. The remaining series 2006B variable rate debt is hedged through a fixed-rate swap that is currently valued at negative $36 million (approximately 18% of fiscal 2014 unrestricted cash). Risk to collateral posting is viewed as low by Fitch, and counterparty termination rights are limited to an event of default by the city. The system's strong unrestricted cash balances and ample rate-raising flexibility also mitigate credit risk to the debt profile.
SIGNIFICANT SUPPLY POSITION
Raw water, derived from reservoirs on the Catawba River that are operated by Duke Energy Company, is projected to remain sufficient for at least 40 years. Water treatment facilities are in good condition and can be expanded to accommodate future growth. Sanitary sewer treatment is provided by five advanced treatment plants, all of which are operating with current national pollution discharge elimination system permits. Treatment capacity comfortably exceeds daily flows.
REGIONAL ECONOMIC CENTER WITH STRONG GROWTH PROSPECTS
The service area's strong economic profile and the system's strong liquidity position help mitigate some of the system's below-average financial and debt metrics. These factors maintained financial stability during the service area's economic contraction in the late 2000's. Fitch expects Charlotte's position as a regional center for trade, transportation, health care, and financial services will contribute to a general trend of economic growth and stability over time. Total employment in Charlotte has increased at a compound annual growth rate (CAGR) of 2.2% from 2005-2014 compared to 0.6% for North Carolina and 0.4% for the nation. IHS, Inc. forecasts job growth at 2.9% CAGR through 2016 ranking Charlotte among the fastest growing large metro areas in the country. City unemployment is low equal to 4.4% as of December 2014.
The city and its economy attract a well-educated workforce; almost 40% of the adult-age population holds a bachelor's degree or higher (140% of the U.S. norm). Recent expansion within technology, pharmaceutical, and energy sectors has the potential to boost already above-average income indices. Per capita money income and median household income are equal to 125% and 113% of the North Carolina average, respectively.
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
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012
U.S. Water and Sewer Revenue Bond Rating Criteria (pub. 31 Jul 2013)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715275
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