Fitch Rates Durham, North Carolina's Wtr/Swr Rfdg Rev Bonds 'AAA'.

NEW YORK -- Fitch Ratings assigns an 'AAA' to Durham, NC, approximately $23.8 million water and sewer utility system refunding revenue bonds, series 2005. The bonds are schedule to price via negotiation with a syndicate led by Wachovia Securities on Oct. 19. Bonds proceeds will advance refund a portion of the outstanding series 1998 and 2001 utility system revenue bonds for net present value savings equal to an estimated 3.1% of the refunded par. At this time Fitch affirms the 'AAA' rating on Durham, NC's approximately $44.2 million outstanding water and sewer utility system revenue bonds series 1994, 1998 and 2001. The Rating Outlook is Stable.

The 'AAA' rating is based on the system's very high liquidity levels, improved operating margins, and the diverse economy of the utility's service area. In March 2004 the utility revenue bonds were rated 'AAA', with a Negative Rating Outlook. The Negative Outlook was based on a deterioration of operating margins. Coverage of senior and subordinate debt, which includes general obligation (GO) bonds issued for water and sewer projects, fell from 1.0 times (x) in fiscal 2002 to 0.6x in fiscal 2003. In addition, the recovery of revenues in fiscal 2004 was softer than anticipated. The revision of the Rating Outlook to Stable in August 2005 was based on an improvement of operating margins that should result in 1x coverage of all debt obligations in fiscal 2005 by system net revenues excluding impact fees. Including impact fees available for debt service, coverage was a more solid 1.2x in fiscal 2004.

The water and sewer system serves approximately 71,400 customers in and around the city of Durham. Due to adverse weather conditions and the loss of a main customer, water consumption decreased for three consecutive years, reducing net income by 51% from fiscal 2001 to fiscal 2003. Net revenue coverage of annual debt service on senior lien debt fell from a high 5.7x in fiscal 2002 to 2.1x in fiscal 2003, but recovered to 3.7x in fiscal 2004. A rate covenant requires that system net revenues excluding impact fees provide 1.2x coverage of senior lien debt and 1x coverage of subordinate obligations. Double-digit rate increases enacted in fiscal 2004 and 2005 resulted in improved operating margins. Projections through fiscal 2010 include rate increases needed to maintain 1.1x coverage on all debt obligations by net revenues.

Rate increases through fiscal 2010 are expected to range between 5.4% and 10.8% annually, but will likely be lower given that projections assume the issuance of about $280 million of debt to fully fund the fiscal 2006-2010 capital improvement plan (CIP). City officials report that most projects included in the plan will not be funded during the fiscal 2006-2010 plan period, and are considering lengthening the time period covered by the CIP to better reflect short-term capital funding need. Plans for water and sewer system debt through fiscal 2010 include the issuance of $20 million of GO bonds scheduled for a referendum vote in November 2005. Historical levels of pay-as-you-go funding have been restored, with operating expenditure projections including $3.5 million annually for funding of capital projects.

Other attributes of the system are strong. Unrestricted cash reserves totaled 710 days cash on hand at the close of fiscal 2004. Treatment capacity in the water and sewer system is ample and customer growth is projected at a manageable 1.96% annually through fiscal 2010. The top 10 water users accounted for 17.28% of water sold in fiscal 2004, with Duke University and Medical Center being the system's largest customer. Despite sizeable rate increases in fiscal 2004 and 2005, the system's rates remain competitive compared to other area utilities. Prior to fiscal 2004, rates had been unchanged or lowered annually between fiscal 1993 and 2003.

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