OREANDA-NEWS. Fitch Ratings has assigned a 'AA+' rating to the following Charleston, SC revenue bonds;

--Approximately $45.9 million waterworks and sewer system refunding revenue bonds, series 2016B.

The bonds are expected to sell via negotiation the week of Aug. 22. Proceeds will be used to refund a portion of the series 2012 revenue bonds for interest cost savings and pay issuance costs.

In addition, Fitch affirms the following rating:

--$586.6 million in outstanding waterworks and sewer system revenue bonds at 'AA+'.

The Rating Outlook is Stable.

SECURITY

The bonds are payable from a senior lien on net revenues of the city's waterworks and sewer system (the system), including impact fees.

No debt service reserve fund is being funded in connection with the series 2016B bonds.

KEY RATING DRIVERS

STRONG FINANCIAL PROFILE: Financial performance has been consistently strong, evidenced by high operating margins, exceptional liquidity, and strong debt service coverage (DSC). Finances are conservatively managed with actual results routinely outperforming financial forecasts. Fitch expects this trend will continue through the current forecast period.

CAPITAL PROGRAM EASING: The system has reached a favorable point in its capital cycle. Average annual capital costs have begun to decrease and are anticipated to decline over the long term. Robust historical capital spending has kept the system very well maintained but resulted in an elevated debt burden.

HIGH LEVERAGE RATIOS: Debt ratios are high compared to similarly rated water and sewer utility systems. However, future capital needs are limited to system renewal and cash reserves are ample, providing flexibility regarding the pace of future investment and an offset to the system's high leverage.

AMPLE INFRASTRUCTURE CAPACITY: System capacity, including raw water supply, remains ample and coupled with planned capital spending for system renewal should provide long-term operating stability.

LONG-TERM PLANNING PRACTICES: Comprehensive long-term financial, capital, and water supply planning practices provide a strong enhancement to credit quality.

RATING SENSITIVITIES

CONTINUATION OF CURRENT TRENDS: The city of Charleston, South Carolina waterworks and sewer system's continued trend of strong financial results coupled with the ability to lower debt ratios would be viewed favorably by Fitch and could lead to consideration of an upgrade.

CREDIT PROFILE

The Charleston Water System (CWS) provides mainly retail water and sewer services to residents of the city of Charleston and significant portions of the surrounding metropolitan area.

SOLID SERVICE AREA

The water system serves 114,500 direct retail accounts, the majority of which live outside of Charleston's city limits, while the sewer system's direct retail customer base is closer to 53,000. The system also provides some wholesale service through long-term contractual agreements with several nearby municipal providers. The customer base is mostly residential with modest annual growth.

CWS is a legally separate entity governed by a five-member board of commissioners. Three commissioners are elected at-large by Charleston residents and the remaining two members are the mayor and one council member.

The service area, anchored by significant military presence and coastal location, is home to Joint Base Charleston and its 22,000 active-duty military personnel and civilians. The metropolitan area's unemployment rate remained low at 4.6% in June 2016, despite growth in the labor force.

STRONG FINANCIAL PERFORMANCE, ABUNDANT LIQUIDITY

Financial results for fiscal 2015 point to strong financial margins, continuing a trend of operating margins that have averaged 51% over the past five fiscal years. Total DSC has been no less than 1.7x from total net revenues, including connections fees, since fiscal 2010 and was a healthy 2.2x in fiscal 2015 due to a combination of rate increases and higher (one-time) connection fee collections. DSC excluding the one-time fees was a still strong 1.8x in fiscal 2015 and has been no lower than 1.6x since fiscal 2010.

Financial projections show DSC from total revenues declining from current levels to a low of about 1.4x in fiscals 2016-2017 before improving in fiscal 2020 to closer to about 1.7x. However, similar to previous pro forma financials provided to Fitch, CWS builds conservative assumptions into the forecast and typically outperforms its annual budget. Consequently, Fitch expects continued strong DSC in the range of historical levels.

The lower projected DSC results from an increase in debt service from the recent debt issuance in 2015 and a 13% rise in operating and maintenance costs in the fiscal 2016 budget, which based on year-to-date results appears very conservative. The forecast also includes already approved rate increases for fiscal 2016 followed by proposed additional 2% and 4% annual rate increases in fiscal years 2018-2020 for water and wastewater, respectively.

Liquidity remains exceptional. Fiscal 2015 results have total unrestricted resources, including non-current (but liquid) investments, totaling approximately $269 million, or a very robust 1,633 days cash on hand. Cash is 5x current liabilities and more than 6x the negative mark-to-market on outstanding swaps. Liquidity is expected to remain very strong, with 49% of five-year capital needs expected to be debt-financed.

WELL-MANAGED OPERATING PROFILE

CWS has ample, long-term supply from two surface water sources, the Bushy Park Reservoir and the Edisto River. Raw water is supplied through large-diameter underground tunnels capable of moving a minimum of 100 million gallons per day (mgd) each. Total supply from the two sources is estimated at 10 billion gallons. Water treatment is handled by the 115 mgd Hanahan Water Treatment Plant. The plant has treated approximately 55 mgd on average over the past five years, leaving plenty of excess capacity. Several points of interconnection within the system and external connection with nearby utilities provide redundancy and emergency supply.

CWS provides retail sewer collection and treatment to nearly all of the water customers within Charleston's city limits and to several thousand additional customers living just outside of the city. Some wholesale service is also provided. Wastewater is treated at the 36 mgd Plum Island treatment facility and a smaller 0.9 mgd plant serving Daniel Island.

Sewer treatment capacity is sufficient with total flows recorded in fiscal 2015 equal to 23 mgd. Treated effluent is released via outfall into Charleston Harbor. Requirements of recently extended treatment and discharge permits are consistently met with no regulatory or environmental issues.

While CWS provides primarily retail service to most of the metropolitan area on a direct basis, it also provides treated water on a wholesale basis to several municipal entities through long-term contractual agreements. Raw water capacity is also provided to several large customers including KapStone Paper and Packaging Corp. and B. P. Amoco Chemical Company. CWS's top 20 water and sewer customers comprise a moderately concentrated 16% of fiscal 2015 operating revenues. However, the leading customer list is comprised mostly of governmental customers, mitigating concentration concerns.

COMPREHENSIVE CAPITAL PLAN, ELEVATED BUT MANAGEABLE DEBT BURDEN

Management's capital planning efforts are robust and include recurring capital improvements as well as longer-term facilities renewal and expansion. CWS has a strong capital reinvestment philosophy, which has resulted in higher debt levels but assets that are in an excellent state of repair.

The capital improvement plan (CIP) incorporates four comprehensive 25-year master plans that cover wastewater treatment, wastewater collection, water treatment, and water distribution. The master plans provide the basis for long-range capital forecasting and are updated periodically.

The CIP through fiscal 2020 totals approximately $341 million with the majority of the plan devoted to system-wide rehabilitation projects. The CIP is comprehensive but flexible with the ability to delay spending on certain projects. Overall, approximately 49% of the CIP is anticipated to be debt-financed with the remainder to be funded from internal sources. Another approximately $168 million parity issuance is anticipated in 2019.

CWS' capital plan is beginning to ramp down. Fiscal 2016 to 2020 total CIP costs are down by 17% from fiscal 2015 to 2019 total plan costs. Average annual capital spending is anticipated to continue to decline from $68 million over fiscal 2016 to 2019 to around $40 million over the fiscal 2019 to 2022 period, which Fitch views favorably.

Leverage of system assets is above average compared with similarly rated credits, both in relation to net capital assets and end users. For fiscal 2015, debt equated to 65% of net plant and approximately $3,900 per direct retail customer. When adding the estimated 21,000 retail customers served through wholesale agreement, debt per customer is lower. However, with the additional planned debt, the system's leverage position is expected to remain elevated over the next five years, particularly since principal amortization is slightly below average; 36% and 83% of all debt will be amortized within 10 and 20 years, respectively ('AA' medians are 40% and 84%, respectively).

Nevertheless, the age of plant is relatively young at 13 years, providing flexibility in execution of the CIP. Management engages in continual review and analysis of the system's major capital projects and associated financings, and actual spending in the next five years seems likely to occur below the conservative $341 million CIP estimate.

RISING USER FEES, AUTONOMOUS RATE SETTING

Rate setting is accomplished by the commission and is independent of outside regulatory influences. The rate structure consists of a minimum base charge for the first 200 cubic feet (cf) of service as well as a volumetric component. The minimum fixed charge accounts for a sizable 45% of the total combined monthly bill, which Fitch views positively as this results in less variability in revenues caused by changes in weather, the economy, or rate elasticity. Rates have been increased roughly annually since fiscal 2004 with little public opposition.

Based on Fitch's standard water usage of 7,500 gallons per month (gpm) and wastewater usage of 6,000 gpm in fiscal 2016, the average monthly in-city retail bill is high at $92, or 2.1% of MHI. The typical CWS in-city customer consumes less water, or about 5,240 gpm, and thus the average actual monthly bill is slightly more affordable at 1.8% of MHI.

Rates are approximately 20% higher for customers living outside of Charleston's city limits. Still, there is some flexibility to raise rates with additional increases to support capital costs and increased debt service payments. No rate increases are expected in fiscal 2017 followed by projected annual increases of 2% for water and 4% for wastewater in fiscal years 2018 to 2020.