OREANDA-NEWS. July 01, 2015. Fitch Ratings affirms the 'AA-' rating on the following Spotsylvania County, VA (the county) revenue bonds:

--Approximately \\$132.5 million water and sewer revenue bonds, series 2005, 2007, 2010A&B and 2013.

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

EXCELLENT LIQUIDITY MITIGATES LOW COVERAGE: The very high cash balances provide a high degree of financial flexibility and a significant offset to low annual debt service coverage (DSC) and free cash flow (FCF) levels.

RATES REMAIN AFFORDABLE: Average customer charges remain low despite a recent rate restructuring to provide for greater fixed-charge coverage. The county has significant rate-setting flexibility and will determine additional multi-year rate increases in late 2015.

ELEVATED DEBT BURDEN: System debt is manageable; however, most ratios exceed Fitch 'AA' medians. The expected issuance of additional bonds coupled with below-average pay-out of existing debt will leave the debt profile somewhat elevated.

MANAGEABLE CAPITAL PROGRAM: System infrastructure is well-maintained and current treatment capacity and water resources are sufficient to meet intermediate-term needs. The capital plan will focus on system upgrades and replacement projects.

STABLE SUBURBAN RESIDENTIAL SERVICE AREA: Spotsylvania County is a growing residential suburban community with strong income and wealth characteristics, low unemployment, and a stable customer base.

RATING SENSITIVITIES

CHANGE IN FINANCIAL PROFILE: Improved operating margins generated by recurring revenues may warrant upward rating action on Spotsylvania. The magnitude of liquid resources makes negative rating action unlikely absent significant financial deterioration.

CREDIT PROFILE

STABLE OPERATING PROFILE, SUBURBAN SERVICE AREA

Spotsylvania County (general obligation bonds rated 'AA+' by Fitch) is a mostly residential community located in northeastern Virginia along the I-95 corridor, within commuting distance of the Washington D.C. (55 miles) and Richmond, VA (55 miles) metropolitan areas. Proximity to these two large employment centers has helped develop the county into a wealthy bedroom community, with development especially prevalent in the northeast portion of the county closest to the interstate. Most of the middle and southern portions of the county remain largely rural, where residents are served by individual septic and well systems.

The system consists of several independent raw water supply sources, distribution and collection assets (pipes), and water and sewer treatment facilities that provide retail service to approximately 29,000 mostly residential water and sewer accounts as of fiscal 2014. The county also provides wholesale water service to the city of Fredericksburg via a long-term (perpetual) contract since 1995. Customer concentration is minimal and wholesale revenues from Fredericksburg account for roughly 6% of system revenue.

FINANCIAL PERFORMANCE IMPROVING, STRONG LIQUIDITY REMAINS KEY

The system's financial profile is mixed. Relatively slim DSC and FCF compare poorly to 'AA' medians but cash balances are very strong. Fiscal 2014 net revenues yielded 1.6x DSC and 1.3x coverage excluding availability fees, falling considerably below the 'AA' medians of 2.5x and 2.3x, respectively. FCF, or net operating revenues available after paying debt service, is fairly low and unable to fully support annual depreciation expenses without available cash and debt resources.

Management historically relied heavily on new-customer connection fee revenue as a source of debt service repayment and cash accumulation. However, during the national economic and housing downturn, new customer growth slowed considerably, resulting in a substantial decline in DSC levels. These slim margins prompted management to modify its billing structure to include higher fixed costs and inclining volumetric tiers. Over time, these changes have led to improved, albeit still-narrow, DSC margins.

Financial projections provided by management anticipate that fiscal 2015 will show 1.5x DSC from all revenues and 1.2x excluding connection fees. Through fiscal 2020, including conservative rate increases and additional debt, DSC is projected to average 1.3x from all revenues and 1.1x excluding connection fees. Coverage projections are weak for the rating category and include increased annual debt service from future anticipated borrowings and reasonable assumptions in demand and customer growth. Fitch's rating anticipates that strong liquidity will continue to offset low expected coverage levels. Improved DSC relative to projections could lead a higher rating given other credit factors.

Cash on hand has averaged more than three years of operations over the past five fiscal years and in fiscal 2014 nearly \\$68 million in unrestricted cash and cash equivalents equated to 1,462 days.

LOW RATES PROVIDE FLEXIBILITY

Significant financial flexibility is provided by the county's low rate structure. According to management the average residential county customer consumes about 4,400 gallons per month (gpm) and paid a combined water/sewer bill of about \\$46 in 2014. This amount equates to only .7% MHI. When scaled up to the national consumption average of 7,500 gpm, the bill is closer to \\$66, or about 1% of MHI. In either scenario the county's rates are considered very low, as they fall well below Fitch's affordability threshold of 2% of MHI for combined rates.

The county's most recent approved rate plan will conclude in fiscal 2016 with a 5% rate increase. Management will propose additional rate increases beyond fiscal 2016 this fall in order to sustain DSC levels of 1.3x including availability fees and 1.0x excluding the fees through fiscal 2020. Fitch expects customer charges to remain very affordable despite anticipated increases.

MANAGEABLE CIP BUT LEVERAGE TO REMAIN ELEVATED

The system's five-year, fiscal 2016-2020 CIP totals \\$75.7 million. The largest projects include improvements to the system's largest water treatment plant and source, the Ni River. Additional projects include constructing new laboratory space and various water and sewer renewal and upgrade projects. Management expects to fund 83% of the CIP with parity bonds and the remaining from internal sources.

The system's roughly \\$133 million debt outstanding yields fairly elevated debt metrics relative to other systems rated in the 'AA' category by Fitch. In fiscal 2014, debt to net plant was 48%, consistent with the 50% 'AA' median, but debt per customer totaled \\$2,441, exceeding the median of \\$1,934. Debt carrying costs are high with all-in annual debt service equal to 34% of fiscal 2014 gross revenues, or over twice that of the 'AA' median. However, other debt ratios are more favorable relative to the medians in fiscal 2014, including debt to equity (1.8x) and funds available for debt service (total debt/net revenues) of 8.5x ('AA' medians are 3.5x and 6.5x, respectively).

System leverage is projected as likely to remain above the 'AA' medians through the five-year forecast, as additional parity bonds totaling \\$63 million are forecast to be issued in fiscals 2017, 2018 and 2019. Inclusive of this projected new debt and accounting for the amortization of existing debt, debt per customer is shown to approach \\$3,000 by fiscal 2019 and annual debt service will consume roughly 40% of gross revenues by that year. The expected pay-out rate, also inclusive of the additional potential debt, aligns fairly well with the 'AA' medians as 43% of principal is amortized over the next 10 years, and 86% is paid out in 20 years ('AA' medians are 39% and 81%, respectively).

POSITIVE ECONOMIC PROFILE, MANAGEABLE GROWTH

Wealth and income levels are well above both the state and national averages. While most residents commute outside of the county for work, local employment is growing with ties to healthcare, construction, retail and wholesale trade, local government, and professional and other services. The county's unemployment rate remained low even during the recession, and at 5.2% in March 2015 is well below the national average. Median household income (MHI) levels are nearly 150% of the U.S. average.

Customer growth remains positive but the rate of growth has slowed in recent years. Additional residential and commercial development continues to occur mostly in the northern sections of the county and in pockets along the I-95 corridor where the bulk of county infrastructure and service is already provided. Management projects this primarily infill development trend to yield roughly 250 new connections annually over the next several years. Infrastructure capacity is currently solid; however, the county expects to double the capacity at the Ni River plant from six mgd to 12 mgd over the next five years in order to maintain ample supply amid anticipated customer growth.