OREANDA-NEWS. Fitch Ratings affirms the 'AA-' rating on the following Gastonia, NC (the city) outstanding revenue bonds:

--\$16.2 million combined utility system revenue bonds series 2005 and 2009.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by a pledge of the city's net water and wastewater system (the system) revenues.

KEY RATING DRIVERS

IMPROVED FINANCIAL PERFORMANCE: Debt service coverage (DSC) and liquidity have improved over time. While financial pro forma indicate that near-term financial results will likely decline with the issuance of additional debt, Fitch expects metrics will stay consistent with the 'AA' rating category.

LOW DEBT TO RISE: The system's low debt burden and associated metrics lend the system ample capacity to issue the expected near- and longer-term revenue bonds and state revolving fund (SRF) loans. While metrics are expected to remain low, future leveraging will more than double the system's current balance.

AFFORDABLE RATES: Fiscal 2014 combined water and sewer rates comprised an unchanged 1.8% of median household income (MHI) for the typical residential customer using 5,000 gallons, below but approaching Fitch's affordability threshold of 2% for combined rates. Rates have not been raised for the past three fiscal years and increases are not likely to exceed 3% going forward.

STRONG OPERATING PROFILE: The system has ample water and sewer treatment capacity and continues its initiative of regionalization by incorporating additional wholesale customers into the system.

CONSERVATIVE, PROACTIVE MANAGEMENT: Experienced and tenured managers conduct frequent pro forma analyses for future rate planning and in order to maintain sufficient operating margins and growing liquidity.

LOCAL ECONOMY IMPROVING: The city has experienced notable employment growth and economic diversification in recent years. The city's 5.2% unemployment rate in December 2014 continues to show improvement and is aligned with the state and national levels.

RATING SENSITIVITIES

FINANCIAL STABILITY AND CAPITAL INVESTMENT: While rating stability is expected in the near-term, sufficient capital spending to address deferred maintenance while maintaining solid DSC and liquidity levels in line with the 'AA' rating medians could support future upward rating movement.

CREDIT PROFILE

STABLE OPERATIONAL PROFILE

The city of Gastonia is located in western North Carolina and provides water and sewer service to over 100,000 residents and 54,000 customers within the city (general obligation bonds rated 'AA' by Fitch) and surrounding towns and municipalities. The customer base is predominantly residential.

The top 10 customers account for only about 10% of the systems total operating revenues and include five stable wholesale municipal customers and a large industrial user. Each of these customers operates under long term, minimum volume-based contracts. The system's permitted raw water allocation is anticipated to meet the needs of the system through 2050, and water and sewer treatment capacity remains ample.

STRONG FINANCIAL PROFILE

The system's financial profile and overall financial flexibility has shown marked improvement in recent years as evidenced by increased free cash flow (FCF), growing operating margins, strong DSC and ample liquidity. Senior lien DSC was 2.7x in fiscal 2014 and all-in DSC that includes low-interest state revolving fund loan annual debt service (ADS) was a still favorable 2.5x. Senior and total DSC improved in fiscal 2014 from the prior year's 1.8x largely as a result of refunding savings in fiscal 2013.

According to a pro forma provided by management, total DSC shows a decline to 1.5x and 1.6x in fiscals 2015 and 2016 due to management budgeting an additional \$2.8 million in ADS for each year as a conservative placeholder for future ADS. Excluding this budgetary item, DSC is likely to improve in fiscals 2015 and to 2.4x and 2.6x. Near-term positive DSC results are in part attributable to management planning to pay down the remaining \$2.7 million in series 2005 bonds on May 1, 2015 from existing cash, removing an estimated \$750,000 of ADS through fiscal 2019. Following the issuance of additional bonds and SRF loans over the next five years, DSC is forecasted to range between 1.5x and 1.9x through fiscal 2019.

The system makes annual payments in lieu of taxes (PILOTs) and other payments to the general fund. These payments are included in the system's operations and maintenance costs in the income statement but are legally paid after debt service. Fitch's analysis considers these to be fixed costs. The payments represent a moderate 7% of operating revenues and are expected to remain stable and consistent over time with minimal to no changes in the calculation formulas. Fitch views favorably the system's strong historic and anticipated DSC levels inclusive of these payments.

The system ended fiscal 2014 with \$19.6 million in unrestricted cash and investments, equating to a positive 306 days' cash on hand (DCOH). An additional \$1.8 million in available restricted renewal and replacement (R&R) funds boosts liquidity closer to 335 DCOH. FCF was a positive 144% of annual depreciation in fiscal 2014 and the system's operating margin was a strong 32%. Liquidity is likely to stay strong as most of the system's five-year capital improvement program (CIP) is debt-financed.

LOW DEBT TO RISE, CAPITAL NEEDS LOOM

The system's debt burden remains low. Debt-to-net-plant was only 16% in fiscal 2014, well below the medians for similarly-rated utilities. In addition, ADS equated to only 16% of gross revenues and long-term debt per customer was a low \$555 that year. Debt levels though will rise over the next few years. Management intends to issue an additional \$15 million in new debt in the next year and also has been allotted \$35 million in 0% interest SRF loans over the next three years to fund the rehabilitation of its sole water treatment plant. While debt metrics will increase, the overall debt burden is expected to remain manageable. Debt per customer is projected to increase to roughly \$1,100 by fiscal 2019 after all of the projected debt has been acquired.

The system's five year CIP totals \$64 million, \$58 million of which will fund an overhaul of the system's sole water treatment plant. The remaining 9% of funding will support R&R projects in order to bring the system into an updated state of good repair. Fitch notes that the system's average age of plant, or the system's audited accumulated depreciation amount divided by annual depreciation, has been steadily rising and equated to 22 years in fiscal 2014 ('AA' median is 14 years). Management's stated goal to dedicate sufficient resources towards R&R are expected to help reverse this trend.

RATES REMAIN AFFORDABLE

Prior multi-year automatic rate increase plans were not implemented given the system's strong and growing cash levels. Management predicts that annual rate increases (if imposed) should not exceed 3% through fiscal 2019. Rate affordability is unlikely to be a concern in the near-term. The monthly residential rate for combined service has remained unchanged for the past three years at \$60 for 5,000 gallons of use. Fitch notes that average customer consumption in Gastonia is lower than the national average, and at a rate of 7,500 gallons per month customer bills would slightly exceed Fitch's affordability threshold.

The rising debt profile will be concurrent with the system's continued incorporation of new wholesale customers as the trend of regionalization continues. Fitch notes that past financial performance trends (and future debt carrying concerns) have been consistently mitigated by the utility and city council's commitment to raise water and sewer rates as necessary.

STABILIZING ECONOMY

The city is located approximately 20 miles west of Charlotte (general obligation bonds rated 'AAA'/Stable Outlook by Fitch). The local economy, historically reliant on a now waning textile and automotive manufacturing sectors, benefits mostly due to its proximity to Charlotte, the country's second largest financial center, and the Charlotte Douglass International Airport (revenue bonds rated 'A+'/Stable Outlook by Fitch), a regional hub. The city has redefined itself as a service, distribution and retail center, and recently developed the Gastonia Technology Park to attract high-tech corporate companies to the area. Unemployment is improving, with the December 2014 rate declining to 5.4%, nearly half of what it was two years prior.