OREANDA-NEWS. Fitch Ratings has assigned an 'AA+' rating for the following Winston-Salem, NC's (the city) revenue bonds:

--Approximately $117 million water and sewer system revenue refunding bonds series 2016A;

--Approximately $11.3 million taxable water and sewer system revenue refunding bonds series 2016B.

The bonds are expected to sell via negotiation on March 16. Bond proceeds will be used to refund the outstanding series 2007A, 2009 and 2010A bonds for interest savings and pay issuance costs. Savings are expected to be taken annually with no extension of maturities.

In addition, Fitch has affirmed the ratings on the following outstanding revenue bonds of the city:

--Approximately $299 million (including the bonds to be refunded) outstanding water and sewer system revenue bonds at 'AA+'.

The Rating Outlook is Stable.

SECURITY

The bonds are payable by a senior lien pledge of the net revenues of the water and sewer system (the system). Revenues include rates, rentals, fees and other income associated with the ownership and operation of the system, but specifically excludes investment income.

KEY RATING DRIVERS

STRONG FINANCIAL FLEXIBILITY: Strong balance sheet resources (in excess of 1,000 days cash on hand [DCOH] in fiscal 2015) and affordable rates provide significant flexibility to the system, helping to offset historically below average debt service coverage (DSC) margins and free cash flow (FCF).

STRONG SYSTEM CAPACITY: Significant capital spending and prudent long-term capital planning has led to abundant water supply and ample system capacity to meet the city's long-term needs. Near-term capital needs are manageable, focusing on sewer improvements and overall system repair and rehabilitation.

DEBT BURDEN WILL REMAIN ELEVATED: Significant capital spending has also resulted in debt ratios that are elevated compared to similarly-rated systems. Expectations for additional debt will keep the debt burden high for the foreseeable future, but manageable at the current rating.

REGIONAL ECONOMIC CENTER: The system is part of the growing 12-county Piedmont-Triad region of North Carolina. The city has become a regional hub for health care, higher education, and biotechnology, having diversified from its traditional concentration in manufacturing.

RATING SENSITIVITIES

CONTINUED FINANCIAL FLEXIBILITY: As Winston-Salem, NC's water and sewer system dedicates greater pay-go resources to capital spending, rating stability will depend upon the maintenance of sufficient cash reserves to offset adequate debt service coverage and free cash flow margins.

SYSTEM LEVERAGE: The greater use of pay-go for capital expenditures will likely preclude the need for additional debt issuances significantly beyond current expectations. However, a higher proportion of debt funding and related leverage could result in downward pressure.

CREDIT PROFILE

REGIONAL SERVICE PROVIDER WITH SOLID ECONOMIC UNDERPINNINGS

The system has transitioned into a regional water and sewer provider, serving the city, several nearby incorporated towns and villages, and most of the unincorporated areas of Forsyth County. Retail service is provided to a growing and mostly residential retail customer base of 116,380 water and 88,600 sewer accounts and a service area population of about 365,000 people. The system's largest 10 users, which include a relatively small amount of wholesale service to several nearby utilities, are relatively diverse, accounting for 16% of system revenue in fiscal 2015. Reynolds American, Inc. is the system's top customer and comprised 4% of total revenues that year.

Forsyth County is a major economic center for northwestern North Carolina, and its principal commercial, retail, and service anchor is Winston-Salem (both the city's and the county's general obligation bonds are rated 'AAA', Outlook Stable by Fitch). Growth in healthcare and higher education has helped diversify the economy, although manufacturing still plays an important role in the employment base. The Winston-Salem metropolitan statistical area unemployment rate has declined over the past years and at 5.1% in November 2015, approximated the 4.9% rate from a year prior.

STRONG CAPITAL PLANNING AND ASSET MANAGEMENT

Significant capital spending has led to an elevated debt burden but also produced ample resources and strong water and sewer treatment capacity. The system also benefits from an abundant water supply from both the Yadkin River and Salem Lake, with the Yadkin River alone capable of supplying all of the area's needs for the foreseeable future. The city owns and operates three water treatment plants that have a combined rated capacity to treat up to 91 million gallons per day (mgd). Annual water treated in fiscal 2015 totaled a consistent 36 mgd, leaving the system with significant excess treatment capacity to serve the residents over the long term. Sanitary sewer treatment is provided by two wastewater treatment plants, with combined capacity of 51 mgd. Sewer flows average around 30 mgd per year and account for roughly 60% of total capacity.

STRONG FINANCIAL FLEXIBILTY

The system's financial position remains strong with notably high cash balances offsetting below average FCF and DSC. Pledged revenues, which exclude investment income but incorporate growth-related conveyance fees, covered annual debt service on senior and subordinate lien obligations by 1.5x in fiscal 2015. FCF, which measures the amount of cash flow available for capital spending after annual payments for operations and debt service, has shown improvement but remains notably low at 57% of depreciation on average over the past five years. While DSC and FCF are low for the rating, the system's exceptionally strong cash position provides ample cushion.

The system ended fiscal 2015 with over $71 million in unrestricted cash and investments, equivalent to almost 700 DCOH. When including renewal and replacement fund balances of about $47 million, DCOH is over 1,100 days. Even when adjusted for a potential (albeit remote) swap termination (detailed below), total liquidity (about 950 days including available restricted cash) is well in excess of both the city's prudent reserve policy that requires one year of operating expenses on hand and Fitch's median for 'AAA'-rated systems.

Fitch believes exceptional liquidity has mitigated historically below average DSC and FCF. Financial projections provided by the city include annual rate increases ranging between 5%-7%, similar to previous forecasts, and all-in ADS coverage of 1.5x-1.8x through fiscal 2022.

Growth in customer accounts has historically helped keep user charges low. Even after boosting water rates by more than 50% and sewer rates by more than 60% since fiscal 2008, the average monthly combined bill of $41 for 600 cubic feet (or about 4,500 gallons) is less than other regional providers and amounts to an affordable 1.1% of median household income.

MODERATE CAPITAL NEEDS

The system's five-year capital improvement plan (CIP) through 2021 totals $304 million and focuses on upgrades to treatment facilities and pump stations and the overall repair and rehabilitation of system assets. Many new capital needs since Fitch's last review were added following recommendations from a 2013 waste water master plan that outlined improvements necessary to expand conveyance flow capacity in targeted parts of the service area. Funding sources include prior bond proceeds, additional bonds totaling $94.5 million and state revolving fund subordinate lien loans of about $67 million. Pay-go sources continue to increase and are expected to range between $20 million - $30 million annually, or about 47% of total resources (up from 27% two years ago).

DEBT TO REMAIN ELEVATED

Debt levels have been historically elevated relative to the 'AA' median rating but have shown improvement in recent years. The current 2016 refunding will provide an estimated $17.4 million in net present value savings, which will be taken annually through 2039. Expectations for additional bonds totaling $100 million in two separate issuances (series 2017 and 2019) will maintain elevated debt levels for the foreseeable future. In fiscal 2015 outstanding debt measured $2,121 per customer and $1,263 per capita and total debt equated to about 62% of the value of system's net fixed assets. The 'AA' medians are $2,050, $577 and 47%, respectively. These levels are expected to rise over the next five years with the aforementioned new bond issuances.

In August 2015 the city refinanced its outstanding variable rate demand bond (VRDB) portfolio (series 2002B, 2002C and 2007B) through a private placement agreement with BB&T bank (rated 'A+' with a Stable Outlook) for a term of 10 years. The privately placed bonds, now series 2015 A, B and C, respectively, carry variable interest rates and maintain their original maturity dates. At the close of the 10 year term (2025), the series 2015C debt will be the only debt remaining with a total of $62.1 million. Through final maturity of the 2015C bonds (2037) the city has the option to remarket through another private placement, refinance in the public market, or redeem the bonds in full in no more than 24 monthly installments. Fitch does not expect the city to have difficulty procuring a new bond purchaser due to the system's general strong credit characteristics.

BB&T's purchase of the VRDB's eliminated the system's potential liquidity risk and need for liquidity products in the case of a failed remarketing. However, the bonds still carry individual fixed-payor swap agreements with counterparty Citigroup, Inc. (issuer default rating of 'A' with a Stable Outlook). The swaps had a total negative valuation of $23.2 million as of December 15, 2015. Swap termination payments are subordinate to senior lien bonds. Fitch believes the system's strong overall credit position significantly limits the likelihood of a swap termination, and its large cash balances provide significant resources to make a termination payment in the unlikely event one is owed in the future.