OREANDA-NEWS. Fitch Ratings affirms the 'AAA' rating on the following bonds issued by the city of Durham, NC (the city):

--\$65.7 million water and sewer utility system (the system) revenue bonds.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by net revenues of the city's combined water and sewer utility system.

KEY RATING DRIVERS

SOUND FINANCIAL METRICS: They system's financial performance remains sound. As calculated by Fitch, all-in debt service coverage (DSC), which includes subordinate debt service on a state revolving fund (SRF) loan and GO bonds issued by the city and supported by the system, improved to 2.3x in fiscal 2014 and has averaged better than 1.9x since 2010.

CAPITAL SPENDING COULD INCREASE DEBT: The system's five-year capital improvement plan (CIP) will likely lead to an increased debt load. However, the system's current debt profile is well positioned to absorb potential new revenue bonds associated with the CIP.

STRONG MANAGEMENT PRACTICES: Conservative budgeting and long-term planning support the system's sound financial results.
ROBUST LOCAL ECONOMY: The economy benefits from an extensive university and healthcare presence, diverse transportation network and proximity to the Research Triangle Park (RTP). Wealth indicators are average, unemployment is below average and the labor pool is highly educated.

RATING SENSITIVITIES
DETERIORATION OF FINANCIAL POSITION: In light of management's forecast of significant capital spending and associated new debt, preservation of liquidity and all-in DSC levels consistent with Fitch's 'AAA' medians is key to maintaining the rating.

CREDIT PROFILE

The combined water and wastewater system serves almost 90,000 customer accounts within the city of Durham (GO bonds rated 'AAA' by Fitch) and significant portions of the unincorporated area of Durham County and the RTP. Slightly more than 90% of system customers reside within the city limits.

SOUND FINANCIAL METRICS

The city's financial profile has been sound over the past five years. Fitch-calculated senior DSC finished fiscal 2014 at a strong 3.8x. Also in fiscal 2014, the system's unrestricted cash balance measured a superb 909 days of operational cash. Both senior DSC and liquidity measure well against Fitch's medians for 'AAA'-rated water and sewer utilities. However, capital expenditures tied to regulatory requirements and system upgrades are projected to lead to a reduction in both of these metrics while at the same time contributing to an increased debt load.

As subordinate debt amortizes and new revenue bonds are issued, senior and subordinate DSC are projected to converge, ultimately reaching management's forecast target of 1.5x DSC. Liquidity is also projected to decrease to its required minimum of 180 days of cash on hand as management expects to draw on its cash reserves for capital projects in order to rely less on debt issuance. Such a decrease in unrestricted cash would be notably lower than other similarly rated utility systems. In Fitch's view, in order to maintain the current rating, a decrease in DSC as forecast combined with a significant decrease in liquidity would pressure the rating and could lead to negative rating action. Nevertheless, management has noted that its previous projections typically consider a conservative, 'worst case' scenario, which historically has been the case in Fitch's previous reviews of management's forecasts.

WELL-POSITIONED DEBT PROFILE

The system's current debt profile is well positioned for bond-related capital expenditures. Current debt-per-customer and debt-to-net plant metrics are low at \$645 and 19%, respectively. However, extensive and costly system upgrades are possible going forward in order to remain compliant with state regulatory requirements. The system's capital improvement plan includes around \$510 million in projects over next the five years beginning in 2016. Of these projects, approximately 65% are anticipated to be funded by debt.

CIP spending has ticked up in recent years as management plans to ramp up spending to meet supply and regulatory requirements. Large water-related projects include almost \$90 million, or approximately 32% of all anticipated water-system spending, dedicated to a new water supply intake and possibly a new water treatment plant on Jordan Lake. The remaining capital expenditures are primarily linked to water system rehabilitation and regulatory requirement upgrades. Projects related to the sewer system primarily address rehabilitation and regulatory requirements. In total, approximately 54% of the CIP is dedicated to water projects and the remainder to sewer. If all of the planned CIP spending is realized, the associated new debt would push debt per customer up to approximately \$2,175 by 2020. At this level, debt metrics would be above Fitch's 'AAA' medians but still manageable.

RATE FLEXIBILITY REMAINS

Assuming 7,500 gallons per month of usage, the combined fiscal 2014 customer bill was approximately \$78 or 1.9% of median household income (MHI). However, actual customer bills as reported by the city have been lower, averaging \$50 monthly or about 1.3% of MHI. This is comfortably below Fitch's affordability threshold of 2% of MHI, leaving ample rate flexibility to offset rising debt obligations.

EXCESS WATER SYSTEM CAPACITY

The system benefits from an ample long-term raw water supply, derived primarily from Lake Michie, which is supplied by the Flat River and the Little River Reservoir. The city also maintains contractual agreements with seven neighboring cities for additional supply through existing interconnections if needed. Both current water supply and treatment capacity at the system's two water treatment plants are more than double the FY 2014 demand of 24 million gallons daily. The wastewater system provides collection, treatment and disposal service and operates two treatment facilities with ample capacity for the foreseeable future.

STABLE AND ROBUST LOCAL ECONOMY

The city's stable and diverse economy is anchored by higher education and healthcare. It is home to Duke University and Medical Center and International Business Machines' (Fitch IDR of 'A+'/Stable Outlook) supply chain management division, which provide over 42,000 jobs collectively. Durham has enjoyed strong employment growth relative to the state and nation over the past several years. The city's December 2014 unemployment rate was 4.1%, which compared favorably to the state rate of 5.2% and national rate of 5.4%. The economy's success is also related to the nearby RTP, one of the most prominent research and development centers in the nation, which has helped draw biotechnology and high-tech firms into the city.