OREANDA-NEWS. Fitch Ratings affirms the 'AAA' rating on the following Henrico County, VA (the county) outstanding revenue bonds:

--$221.7 million water and sewer system revenue bonds.

The Rating Outlook is revised to Stable from Negative.

SECURITY

The bonds are secured by a senior lien of net revenues from the county's water and sewer system (the system).

KEY RATING DRIVERS

IMPROVED DEBT SERVICE COVERAGE: The Outlook revision to Stable from Negative reflects improvement in financial margins over the last few years, particularly in terms of debt service coverage (DSC). Management aims to maintain DSC at or above 2.0x.

HEALTHY LIQUIDITY: The county maintains very good liquidity with unrestricted cash and investments at over 300 days of operating expenses as of fiscal 2015.

DEBT LOAD TO INCREASE: Debt ratios are expected to increase to above-average levels over the next five years with additional borrowing expected to finance capital needs.

RATES REMAIN VERY AFFORDABLE: Projected rates through 2020 are expected to remain very affordable, well below Fitch's threshold of 2% of median household income (MHI).

AMPLE SYSTEM CAPACITY: While costly, once the Cobbs Creek Reservoir (CCR) project is complete, system capacity should provide long-term operating stability.

STRONG ECONOMY: The service area is broad and diverse, as reflected by low unemployment, above-average wealth levels, and a highly diverse customer base.

RATING SENSITIVITIES

DETERIORATION IN FINANCIAL METRICS: Actual DSC results have consistently beaten projections, but declines are forecast with the issuance of bonds over the next few years. Realization of projected declines in DSC over the forecast period and/or ongoing weak results in other key financial metrics could result in downward rating pressure given the expectation of increased leveraging.

CREDIT PROFILE

Henrico County (general obligations bonds rated 'AAA' by Fitch) is located in central Virginia and surrounds the city of Richmond (the city) on the north side of the James River. The system provides service to approximately 63% of the geographical area of the county. The county's utility system provides retail service to approximately 96,000 water and 93,000 sewer customers. The county also has service agreements to supply limited amounts of water to Hanover County and Goochland County, and to treat a limited quantity of wastewater from Hanover County, Goochland County, and the city.

Currently about 30% of the county's water supply is purchased from the city. The remainder is supplied by the county's 80 million gallon per day (MGD) recently expanded water treatment plant. The county operates a 75 MGD wastewater treatment facility. Both the water and wastewater treatment plants had ample capacity remaining based on average daily flows, with 74% and 69% capacity remaining as of fiscal year-end 2015.

SOLID FINANCIAL RESULTS

Financial performance remains healthy as evidenced by sound liquidity and strong DSC levels. For fiscal 2015, total DSC was a strong 2.6x (relative to Fitch's 'AAA' median of 2.8x), outpacing prior years' performance and prior financial projections. As the system's fixed costs rise with anticipated debt issuances, DSC may be pressured. Currently, the county's forecast projects DSC dipping below the county's target of 2.0x by fiscal 2017. However, county financial projections have consistently been conservative and Fitch expects such outperformance to continue.

Days cash on hand totaled a favorable 338 in fiscal 2015. Cash levels have declined over the last eight fiscal years to fund capital projects. Liquidity may decline further to some extent over the next few years based on planned pay-as-you-go capital funding through fiscal 2020. However, Fitch expects the county will balance pay-go capital spending with maintenance of sound reserve levels commensurate with the rating level.

DEBT BURDEN TO RISE
The system's five-year CIP for fiscals 2016 - 2020 totals $497 million, of which 69% is expected to be debt-funded. Roughly 28% of plan costs are for the CCR project, with the remaining 59% and 12% for various sewer and water projects, respectively. The county plans to issue approximately $90 million in the spring of 2016, followed by additional issuances of $155 million in 2018 and $100 million in 2020. The remaining 30% of the CIP is anticipated to be funded from pay-go and unspent bond proceeds.

The five-year fiscal 2016 to 2020 capital spending plan is up by approximately $92 million or 23% over the fiscal 2014 to 2018 CIP to accommodate some additional sewer system improvement projects. While debt per customer as of fiscal 2015 ($1,224) is comparable to Fitch's 'AAA' medians, debt per customer is projected to increase by 120% to $2,701 in the next five years. Debt amortization is average, with payout of existing debt at 41% and 83% in 10 and 20 years, respectively, ensuring the debt burden will remain somewhat elevated for some time until average annual capital spending declines well below current norms.

THE COBBS CREEK RESERVOIR PROJECT AND SYSTEM NEEDS

Capital planning is strong and remains focused on sustaining solid water supply, storage and treatment capacity for several years. Approximately 28% (or $140 million) of the current CIP spending is earmarked for the CCR project, which the county will own and operate. The regional project will position the county to have ample water supply through 2055.

The project is a river flow augmentation project that will discharge up to 100 MGD of raw water into the James River during periods of low flow in the river. The project involves construction of a pair of dams that will block flow from Cobbs Creek. When the James River is at high flow during the winter, excess river water will be pumped uphill into the CCR. Dam construction is anticipated to be completed in 2019, and it will take approximately two years to fill the 1,100-acre reservoir that will be located in Cumberland County.

Up to 47 MGD will be released from the reservoir during periods of high demand to bolster the flow of the James River when natural flow drops. The county plans to ultimately withdraw 30 MGD (already permitted), Cumberland County will be able to withdraw up to 7 MGD, and Powhatan County will be able to withdraw up to 10 MGD.

The county's remaining appropriation for the regional reservoir project totals $140 million. The county is currently in phase II of the project (phase I or acquisition of all of the properties has been completed) and is in the process of clearing the new utility corridor to where it will move existing utilities. The reservoir should be completed and ready for use by 2022.

Approximately $295 million or 59% of the CIP is dedicated for sewer system improvements, including completing the final eight of 34 consent order projects to minimize overflows and inflow and infiltration problems. Fitch notes that the system is in compliance with the Chesapeake Bay Act requirements to date. The remaining $62 million or 12% of the CIP is for water system related projects. The county recently completed the expansion of its water treatment plant from 55 MGD to 80 MGD. The plant's expansion coupled with a treated water supply contract (through 2040) with the city of Richmond, VA, provides ample treatment capacity for the next several years.

RATES TO REMAIN AFFORDABLE DESPITE FUTURE ADJUSTMENTS

To offset the increased costs of the upcoming debt issuances and generate sound DSC, the county is forecasting rate hikes averaging 5% annually through fiscal 2020. Historically, the county has raised rates on a consistent basis to offset capital costs. Currently, user charges at $38.55 as of fiscal 2015 (based on Fitch's standard usage of 7,500 gallons per month for water and 6,000 gallons per month for sewer) are very affordable at just 0.8% of MHI.

Even with projected rate increases of 5% annually through 2020, rates are anticipated to remain affordable. Fitch notes that the typical residential county customer consumes 5,330 gallons per month of water, so rates are even more affordable when taking actual water usage into consideration.

SOLID SERVICE TERRITORY

Henrico County continues to show solid economic growth. The unemployment rate at 4.1% as of September 2015 is below the national (4.9%) average for the month. The county's local employment base is substantial and residents have additional job opportunities in the vital government and commercial centers of the neighboring capital city. MHI levels in the county are good at 96% and 116% of state and national averages, respectively.