Fitch Affirms Henrico County, VA Water and Sewer Revs 'AAA'; Outlook Remains Negative

Fitch Ratings affirms its 'AAA' rating on the following Henrico County, Virginia (the county) obligations:

--$162 million outstanding water and sewer system revenue bonds.

The Rating Outlook remains 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

PLANNED LEVERAGING DRIVES NEGATIVE OUTLOOK: While debt ratios are currently consistent with 'AAA' rating category median levels, the aggressive capital improvement plan (CIP) will result in ratios that greatly exceed median levels over the next five years. Planned leveraging without commensurate improvement in financial results would likely lead to a negative change in the rating.

STRONG FINANCIAL PROFILE: Financial performance in terms of debt service coverage (DSC) and liquidity remain solid. However, metrics have diminished from previous highs.

RATES REMAIN AFFORDABLE: Projected rates through 2017 are expected to remain affordable, below Fitch's threshold of 2% of median household income (MHI). In addition, user charges are currently comparable to other regional providers.

AMPLE COMBINED SYSTEM CAPACITY: While aggressive, management's long-term capital planning will help sustain the system's strong supply, storage and treatment capacity for several years.

STRONG ECONOMY: The service area exhibits sound economic underpinning and includes low unemployment and above-average wealth levels.

RATING SENSITIVITIES

INCREASED LEVERAGING WITHOUT OFFSETTING CONSIDERATIONS: Absent a reduction in planned leveraging, commensurate increases in financial performance will be necessary in order to maintain the current rating level.

CREDIT PROFILE

PLANNED GROWTH IN DEBT LOAD KEEPS OUTLOOK NEGATIVE

The system's five-year CIP for fiscals 2014-2018 totals $404 million, of which 79% is expected to be debt-funded. The county plans to issue approximately $75 million in spring 2014 followed by additional issuances of $125 million in 2016 and $120 million in 2018. While the current CIP is down 31% from last year's CIP and the current debt per customer ($902) is slightly lower than Fitch's 'AAA' medians, projected debt per customer is still expected to escalate dramatically, rising to $2,502, or almost 60% higher than Fitch's 'AAA' medians.

The county has noted some flexibility in the timing and sizing of the CIP or in making certain equity contributions earlier than planned, which may lead to a smoothing of capital expenditures. Nevertheless, the current planned rapid increase in leverage ratios is of concern. Such deterioration in the debt profile without sustained offsetting improvement in other credit characteristics - particularly in the financial profile - will likely result in a downgrade of the credit.

SOLID LONG-TERM PLANNING TO ENSURE AMPLE SYSTEM CAPACITY

Capital planning is strong and remains focused to help sustain solid supply, storage and treatment capacity for several years. Approximately 40% of the current CIP spending is earmarked for the Cobbs Creek Reservoir project, which will significantly increase the county's water supply. The project is a river flow augmentation facility that will discharge raw water into the James River during periods of low flow. The addition of the new reservoir will position the county to have ample water supply through 2055.

The total cost of the reservoir project is estimated at $280 million, of which $160 million is included in the current CIP. Preliminary construction on the reservoir and associated facilities is scheduled to begin in 2015, with an anticipated completion date of 2020; filling of the reservoir is expected to take approximately two years.

The remaining portion of the CIP is aimed at maintaining regulatory compliance and improving assets. By the spring of 2014, the system expects to have completed the expansion of its 55 million gallon per day (mgd) water treatment plant to 80 mgd. The plants' 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.

SOLID FINANCIAL RESULTS

Financial performance remains healthy as evidenced by sound liquidity and strong DSC levels. While days cash on hand totaled a favorable 323 days in fiscal 2013, cash levels have declined over the last six fiscal years to fund capital items. Based on planned pay-as-you-go capital funding through fiscal 2018, liquidity levels may decline slightly but should remain adequate.

For fiscal 2013, total DSC was a strong 2.5x, outpacing prior years' performance and prior financial projections. However, 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 2.0x DSC guideline by fiscal 2017, although county financial projections have typically been conservative.

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 2017. Historically, the county has raised rates on a consistent basis to offset capital costs. Currently, user charges, based on approximately 7,500 gallons (Fitch's assumption for U.S. average household consumption), have risen to a moderately high 1.5% of MHI. This affordability measure is well above the 1.1% median for other 'AAA' category credits and is expected to increase to 1.6% by 2017, approaching Fitch's affordability threshold of 2.0% taking into account planned adjustments.

Somewhat offsetting cost concerns, current charges based on the system's actual average consumption of approximately 5,300 gallons are more affordable at $58 per month or 1.1% of MHI. By fiscal 2017, the county estimates that its utility charges will total $67 per month or 1.3% of MHI. In addition, current rates are in line with other regional providers.

SOLID SERVICE TERRITORY

Henrico County surrounds the state capital of Richmond on the north side of the James River and continues to show solid economic growth. The unemployment rate at 5.2% as of October 2013 is well below the 7% national 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. Median household income levels in the county are good at 97% and 116% of state and national averages, respectively.

Additional information is available at 'www.fitchratings.com'.

In addition to the sources of information identified in Fitch's U.S. Municipal Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope and Black & Veach (Rate Consultants).

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria', June 3, 2013;

--'U.S. Water and Sewer Revenue Bond Rating Criteria', Aug. 3, 2013;

--'2014 Water and Sewer Medians', dated Dec. 12, 2013;

--'2014 Outlook: Water and Sewer Sector', dated Dec. 12, 2013.

Applicable Criteria and Related Research:

2014 Outlook: Water and Sewer Sector

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724357

2014 Water and Sewer Medians

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724358

U.S. Water and Sewer Revenue Bond Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715275

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709499

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=815379

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