OREANDA-NEWS. Fitch Ratings assigns an 'AA-' rating to the following Hamilton, OH (the city) revenue bonds:

--$11.1 million water system improvement and refunding bonds, series 2015.

The bonds are expected to sell via negotiated sale the week of Sept. 14.

Proceeds will be used to currently refund the city's water system revenue refunding bonds, series 2002; discharge at maturity the city's $6.7 million water system improvement general obligation (limited tax) bond anticipation notes, series 2014; pay costs to construct certain improvements to the city's water system (the system); and pay issuance costs.

The Rating Outlook is Stable.

SECURITY

The bonds are payable from a senior lien pledge of the net revenues of the system.

KEY RATING DRIVERS

HEALTHY EXISTING FINANCIAL PROFILE: Key financial metrics such as debt service coverage (DSC) and liquidity have shown very positive results in recent years as a result of consistent rate increases and expenditure controls.

LOWER COVERAGE EXPECTED: A five-year financial forecast predicts a decline in the system's currently strong financial results as the bulk rate charge for the system's largest wholesale customer is adjusted downward and annual debt service (ADS) rises.

SUFFICIENT RATE SETTING FLEXIBILITY: The city's water charges are affordable and management has sound rate-raising flexibility. Flexibility is further enhanced by management's ability, as authorized by city council, to levy any of four individual rate riders on top of regular rates to respond to changes in capital needs.

LOW DEBT PROFILE: The system has maintained low debt levels over time as reflected by modest per-customer carrying costs and relative to the system's overall net capital assets. However, amortization is slow and a portion of the series 2015 issuance will refund and re-structure the amortization of the 2002 bonds by nine additional years.

MODEST CAPITAL NEEDS: The system's capital needs are manageable through the five-year period and are not constrained by regulatory mandates.

GROWING SERVICE TERRITORY: The city's retail service area is small, although it also serves Butler County on a wholesale basis and is part of a diverse and growing economic base proximate to both Cincinnati and Dayton.

RATING SENSITIVITIES

ANTICIPATED FINANCIAL RESULTS: Management's ability to achieve financial results similar to or better than the current forecast despite the downward adjustment of bulk rate charges of Butler County, the system's largest water customer, will be necessary to support upward rating mobility.

CONTINUED ECONOMIC IMPROVEMENT: Continued gains and expansion in economic activity would be viewed favorably given the below-average wealth levels within the city and the expectation of additional rate hikes on the service base.

CREDIT PROFILE

The city of Hamilton is the county seat of Butler County (the county) and is located in south western Ohio, 30 miles north of Cincinnati and 40 miles west of Dayton. The utility serves approximately 24,300 customers from groundwater resources that reportedly are high quality and more than sufficient to meet long-term demands. The customer base is predominately residential with minimal customer concentration. The city also provides wholesale service to the county, which has typically accounted for over 50% of the system's annual revenues.

SOLID FINANCIAL PROFILE

The system's financial profile has shown steady improvement since fiscal 2009 due a combination of consistent rate increases and expenditure reductions. As of fiscal 2014, most financial metrics were commensurate with the 'AA' rating category medians (the 'AA' medians). Net revenues yielded a strong 2.4x DSC and the system's $9.1 million in unrestricted cash equated to a robust 351 days cash on hand (DCOH). When incorporating an additional $1 million in restricted rate stabilization funds that are available for operations, liquidity improves to an even stronger 390 DCOH. Free cash flow relative to annual depreciation expense has averaged below 100% since fiscal 2009 but has trended upward and equaled 111% in fiscal 2014.

AFFORDABLE RATES

The average residential customer pays $23 for about 5,200 gallons per month (gpm) of water service, equating to 0.5% of median household income (MHI), well below Fitch's 1% of MHI affordability standard. Charges are also favorable relative to other southwest Ohio utilities.

The rate structure is comprised of both a fixed and volumetric component, the former equating to a strong 33% of monthly costs. In addition to the normal monthly rate structure, the city has the ability to charge any of four city council-authorized rate riders on top of existing rates should the need arise. These riders are for unfunded governmental and regulatory environmental mandates, economic development costs, a water main replacement program, and for rate stabilization fund replenishment. None of these options are currently levied.

Management has consistently raised rates in recent years, and following a comprehensive rate study performed in 2014 passed a five-year rate package beginning in fiscal 2015. The rate package will result in cumulative increases to current residential customer costs of 26% by fiscal 2019, pushing charges to an estimated 0.9% of MHI. The rising charges could possibly constrain rate-raising flexibility over time.

MODIFIED COUNTY AGREEMENT IMPACTS FINANCES

The residential rate increases are in part designed to offset a decrease in the city's bulk charge to the county. In 2014 the city and county re-negotiated the water purchase agreement in order for the city to provide the city with a competitive edge against Cincinnati (the county's other water provider), retain the county as a long-time customer, and eventually become its exclusive water provider; the county does not currently own or operate any raw water supply or treatment facilities.

The city's bulk rate was revised to a single tier of $1.66 per 1,000 gallons from the prior two-tiered system of $2.78 per 1,000 gallons for the first 8 million gallons per day (mgd) and $1.76 for each additional 1,000 gallons. Beginning in 2022 this rate is allowed to increase by the lesser of the consumer price index or 3.25%. In consideration of the lower rate, a 'take-or-pay' component was added to its contract, whereby the county must purchase a minimum of 8 mgd per year. In addition, the county is required to purchase 100% of its water needs from the city by 2026 at which time the minimum take-or-pay amount will increase to 12 mgd. The contract will last for 30 years (through 2044) compared to the prior agreement, which was set to expire in 2021.

Future financial projections provided by management indicate that operating revenues will decline by 15% in fiscal 2015 as a direct result of the downward bulk rate adjustment. DSC is projected to drop to 1.6x that year as net revenues decline and ADS increases slightly. Revenue is expected to grow by a modest annual 3% through 2019 due to the continued upward residential rate adjustments, offsetting a similar rise in operating expenses and allowing pro forma DSC to remain stable at around 1.7x.

Fitch views management's ability to secure Butler County as a long-term, eventually exclusive customer positively. The strength of expected financial results is captured in the current rating level as the decline in revenue projections are considered reasonable and likely to play out. Fitch will re-assess the system's financial performance as actual results from the renegotiated water purchase agreement terms are realized over time and take further action as needed.

FAVORABLE DEBT BURDEN

Current debt metrics are a positive credit factor. Debt-per-customer and per-capita metrics were low in fiscal 2014 at $1,206 and $470, respectively, relative to Fitch's corresponding 'AA' medians of $1,934 and $521. Debt to net plant was also low in fiscal 2014 at only 29% compared to the 'AA' median of 50%, and ADS carrying costs were a manageable 14% of gross revenues ('AA' median is 23%).

Management intends to issue an additional $10.4 million in fiscal 2017 and $5.6 million in fiscal 2020. This will cause some erosion in the system's debt profile, but metrics should remain favorable overall over the next five years, apart from principal amortization, which is slow; only 27% is retired in 10 years and 65% is paid in 20 years compared to the 'AA' medians are 39% and 81% respectively).

A portion of the series 2015 bonds ($5.2 million) will be used to refund and restructure the outstanding series 2002 bonds and extend the final maturity by nine years to 2030, which Fitch views unfavorably given the extended pace of the system's debt amortization. The refunding will yield a minimal net present value savings of about $200,000. The main benefit of the refunding will be the reduction of ADS costs by roughly $500,000.

LIMITED CAPITAL NEEDS

The city's capital improvement program (CIP) totals a manageable $19.3 million over fiscal years 2016-2020, equating to a low $144 average annual CIP cost per customer. The utility's largest stated need, accounting for 65% of the five-year CIP, is the renewal and replacement of its aging water main infrastructure. There are currently no regulatory requirements pending against the city, granting management substantial capital planning flexibility.

IMPROVING ECONOMY

Hamilton has a growing and diversifying economy composed primarily of higher education, healthcare, government, and manufacturing. The city benefits from its close proximity to Cincinnati and Dayton, which also provide significant employment opportunities. Following the closure of two major local paper mills in 2011 and 2012, management has reported the creation of nearly 2,700 new jobs generated by new and expanding businesses, helping to return employment to pre-recession levels. Management predicts a continuation of economic revival within its downtown and existing industrial parks.

The city's unemployment rate continues to improve, after historically being higher than the state and U.S. As of June 2015, the city's unemployment rate of 5% compared favorably to the 4.8% rate of Butler County, the 5.2% state rate and the 5.5% national rate. Per-capita money income is below average at 84% and 76% of state and national averages, respectively, and in-city poverty levels are an elevated 23% compared to 15.8% for the state and 15.4% for the U.S.