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Fitch Rates Fayetteville, NC's Public Works Commission 2018 Rev Bonds 'AA'; Outlook Stable.

New York: Fitch Ratings has assigned a 'AA' rating to the Fayetteville (NC) Public Works Commission's (PWC) issuance of approximately $87.355 million, series 2018 public works commission revenue bonds.

Bond proceeds will fund capital expenditures, currently refund a portion of outstanding series 2009A revenue bonds, and pay costs of issuance. The fixed rate 2018 bonds are scheduled to price on Nov. 27, 2018.

Fitch also affirms the 'AA' ratings on PWC's outstanding series 2014 ($109.74 million) and series 2016 ($111.43 million) parity revenue bonds (as of June 30, 2018).

The Rating Outlook is Stable.

SECURITY

The bonds are special obligations of the PWC and are secured solely by net revenues of the combined enterprise system, which is composed of the electric, water, and wastewater systems.

KEY RATING DRIVERS

SOUND COMBINED UTILITY SYSTEM: PWC operates a combined utility system that provides electric, water, and wastewater services. The majority of revenues (64%) are derived from the PWC's electric distribution system and each of the systems is financially self-supporting.

ALL-REQUIREMENTS POWER SUPPLY: The system's wholesale power is provided through an all-requirements contract with Duke Energy Progress, Inc. (DEP). DEP's obligations are supported by a sizable and well-diversified portfolio of resources, but increasing environmental costs related to coal ash remediation are expected to drive power costs higher. PWC is currently evaluating power supply options as it may elect to terminate the DEP power supply agreement on July 1, 2024, with written notice provided to DEP by Dec. 31, 2019.

RATE FLEXIBILITY AND PLANNED INCREASES: PWC's electric, water, and wastewater rates are competitive for the region, providing rate and financial flexibility. Implementation of planned rate increases should absorb increased power supply and debt service costs. PWC's ability to establish financial policies and set its own rates, budgets and reserves without the city's approval was codified following amendments to the City of Fayetteville Charter.

STRONG FINANCIAL METRICS: Strong operating cash flow and sound liquidity support PWC's solid financial position. Fitch-calculated debt service coverage (DSC) and coverage of full obligations were healthy at 3.3x and 1.7x, respectively, in fiscal 2018. Coverage of full obligations, which includes city transfers and a portion of purchased power as debt service, is anticipated to fall below 1.5x for the next two years as a result of higher power costs and capital spending. Anticipated rate increases should restore coverage metrics in the latter forecast years. Liquidity is projected to remain sound.

INCREASING LEVERAGE: PWC's current leverage position is in line with category medians. However, additional planned debt issuances to fund large capital expenditures over the next five years will increase leverage. Metrics should remain minimally acceptable for the rating category with anticipated rate increases.

STABLE SERVICE AREA: The local economy benefits from the continued growth in and around the Fort Bragg military base. Relatively stable sectors, including government, education and healthcare, continue to drive slow but steady growth in the service area.

RATING SENSITIVITIES

INCREASING LEVERAGE: The Fayetteville (NC) Public Works Commission's current rating reflects Fitch's expectation that planned rate increases will be implemented to recover higher power costs, increased capital investment and rising debt burden. Failure to meet projected financial results, in particular leverage, will put downward pressure on the rating.

CREDIT PROFILE

PWC operates a combined utility system, including electric, water and wastewater, throughout a region that encompasses the City of Fayetteville, NC and portions of the broader Cumberland County. The majority of customers are within city limits (approximately 85% of electric customers).

Fayetteville is the sixth-largest city in North Carolina and its economy is heavily dependent on the government sector. Approximately 53,000 military personnel are stationed at Fort Bragg and Pope Army Field. Additionally, 50% of non-military wages in Fayetteville are government based, including local governments, school districts and veterans' hospitals and services.

INCREASED POWER SUPPLY COSTS

PWC receives its power from DEP through a 30-year all-requirements contract that was entered into on July 1, 2012. The contract allows for PWC to receive a small portion of its power from an existing contract with Southeastern Power Administration, which provides less than 1% of PWC's annual energy supply. DEP's obligations are supported by a well-diversified portfolio of generation resources that totaled approximately 12,809 MW as of Dec. 31, 2017.

PWC is currently evaluating its power supply options. PWC may elect to terminate the DEP power supply agreement on July 1, 2024 if PWC provides written notice to DEP by Dec. 31, 2019. PWC management's selection of a power supplier (including DEP) would be based on price, viability of the supplier and the reliability of the power supply.

In September 2014, North Carolina passed the Coal Ash Management Act (CAMA) to address the handling, disposal and remediation of coal combustion residuals. DEP has estimated that compliance with federal and state environmental laws regarding coal ash management will result in an additional $4 billion in costs, of which PWC could be responsible for up to $74 million. DEP began passing CAMA costs to PWC in fiscal 2018 and PWC management expects a majority of the costs will be recovered prior to 2024. Declines in coverage ratios related to CAMA will be mitigated by a $2 monthly coal ash fee to PWC customers and the use of PWC's coal ash reserve fund ($28.3 million) and electric rate stab fund.

COMPETITIVE RETAIL RATES

PWC's electric system accounts for the majority (64%) of the combined system's revenues. The utility's electric rates are competitive, which provides management with additional rate making flexibility. PWC implemented a 2.7% rate increase in fiscal 2018 following a revenue neutral rate design during fiscal 2017. An additional rate increase of 2.7% was approved for fiscal 2019, but the PWC has chosen to rescind the rate change and allow customers to adjust to the new time-of-use rates being implemented. PWC also has a wholesale power cost adjustment charge, which is designed to fluctuate annually to capture under- or over-recovery of power supply costs from the preceding year.

Both the water and wastewater systems have been implementing annual rate increases since 2004. Rates have increased to fund ongoing maintenance and upgrades of the systems. Even after the increases, PWC's water and wastewater rates remain among the lowest in the region.

Additionally, PWC maintains electric and water/wastewater rate stabilization (RSF) funds to ensure rate stability and competitiveness. PWC withdrew approximately $11.5 million on average annually from the electric fund during fiscals 2014 through 2016 to offset increased power supply costs from DEP. PWC has since replenished the electric RSF, with a balance of $48.8 million for fiscal year-end 2018 (or roughly equivalent to 18% of total operating expenses). Funds in the water/wastewater rate stabilization accounts were more modest at $578.3 thousand for fiscal year 2018.

STRONG FINANCIAL PERFORMANCE

PWC's combined financial position is strong and remains in line with 'AA' medians. Fitch-calculated DSC averaged 3.1x in fiscals 2014-2018. Coverage of full obligations, which includes a fixed charge for PWC's purchased power obligations and includes the city transfers, has averaged 1.58x for the past five years, commensurate with their 'AA' rated peers. Coverage of full obligations is expected to moderately tighten in fiscal 2019-2020, primarily due to increased power and coal ash costs. Coal ash costs will largely be covered through cash reserves, rather than operating cash flow. However, Fitch anticipates coverage of full obligations to rebound to 1.7x by fiscal 2022 as planned rate increases are implemented and debt service moderates. Liquidity should remain strong, with healthy operating cash flow being generated through the capital expenditure cycle.

INCREASED CAPITAL SPENDING; GROWING LEVERAGE

Fitch expects capital expenditures to rise, increasing to an average annual spend of approximately $125.9 million in fiscals 2019-2023, relative to the $76.6 million average annual capital expenditures in the preceding five years. Significant portions of the funds will be directed to the water and wastewater treatment plant expansions and the remaining investments will be primarily dedicated to system improvements.

PWC intends to finance the capital expenditures through a combination of operating cash flow, revenue bonds, reserves and third-party contributions. In addition to the series 2018 ($87.36 million) revenue bonds, PWC projects debt issuances of approximately $278 million, in aggregate, during the five-year forecast period - roughly doubling PWC's debt outstanding. Fitch calculated leverage, as measured by net adjusted debt to adjusted funds available for debt service, will rise from 4.2x in FY2018 to roughly 6x in the forecast period - minimally acceptable for the rating category. PWC has historically maintained a strong balance sheet, with equity capitalization of 76.3% in fiscal 2018. Additionally, PWC's forecast conservatively includes a major system project in the final forecast year (2023), which is likely to be delayed depending on system growth.
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Publication:Daily the Pak Banker (Lahore, Pakistan)
Geographic Code:1U5NC
Date:Jan 11, 2019
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