Fitch Ratings takes the following rating action on Norfolk, VA's revenue bonds:

--Approximately $181 million water revenue refunding bonds series 2012 rated 'AA+'.

The bonds are expected to sell the week of March 19 via negotiation.

Proceeds of the series 2012 bonds will be used to refund all or a portion of various outstanding parity bonds for savings, and pay issuance costs.

In addition, Fitch affirms the following ratings:

--Approximately $115 million in outstanding water revenue bonds (various series) at 'AA+'.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by a senior lien pledge of the net revenues of the water system (the system). The existing common debt service reserve fund will not cover the 2012 bonds.

KEY RATING DRIVERS

LARGE REGIONAL PROVIDER: Norfolk's water system is the primary service provider for a large, mostly residential, and economically stable region. The system directly serves over 65,000 retail accounts, and an additional 196,000 retail customers through wholesale contracts.

HYBRID SYSTEM; STABLE FINANCIAL MANAGEMENT: Fitch views coverage levels as adequate despite being below average for retail systems. Over 50% of operating revenues are derived from wholesale customers making the system somewhat unique. Fitch is comfortable with coverage levels more consistent with wholesale systems given the ability to pass through costs and importantly, the systems strong liquidity.

STRONG SYSTEM CAPACITY: Ample water supply and treatment capacity provides operating flexibility and limits short-term capital needs mainly to repair, replacement, and maintenance projects.

BELOW AVERAGE DEBT BURDEN: Debt ratios are manageable when including all of the system's direct retail customers, and the retail customers it serves on a wholesale basis. A mainly debt-financed capital plan is expected to only modestly raise the debt burden.

BELOW AVERAGE LEGAL PROVISIONS: Legal provisions are below average compared to typical utility systems Fitch rates. The rate covenant and additional bonds test require just 1.1x debt service coverage from net revenues.

CREDIT PROFILE

Role as Regional Service Provider a Credit Positive

The city of Norfolk (general obligation bonds rated 'AA+' by Fitch) is located in the Hampton Roads region of Virginia, along the Atlantic Ocean. The city covers 66 square miles and has an estimated current population of 244,000.

The system is the primary water provider for the entire region, providing retail service to its own roughly 65,500 mostly-residential customers and wholesale service to the city of Virginia Beach (water and sewer revenue bonds rated 'AAA' by Fitch), the U.S. Navy, and other nearby communities. The entire service area covers more than 330 square miles, includes a total retail customer base of more than 260,000, and serves a population of about 1,100,000, according to city estimates.

The area is mostly residential in nature; although its favorable location promotes significant industrial, trade, and tourist activities. The economy, which is anchored by the presence of the U.S. military, is beginning to expand with employment gains in business and other services. A large commercial port and Norfolk International Airport provide significant employment and trade opportunities. The unemployment rate remains above historical levels at 7.1% as of December 2011.

Long-term Contracts Provide Stability and Offsets Concentration

While customer concentration is moderately high, Norfolk provides service to several highly rated utility systems in the region through mainly long-term wholesale contracts. The city of Virginia Beach is the system's largest wholesale customer, comprising 35% of total revenues in 2011. Pursuant to the long-term water services contract, which expires in 2030, Norfolk receives and treats raw water from Virginia Beach and conveys potable water back to Virginia Beach up to an average of 45 mgd.

Virginia Beach is charged based on a cost of service approach, whereby it pays Norfolk a proportionate share of operations and maintenance expenses, depreciation expense, and a return on assets. Such payments are designated as operating expenses of the Virginia Beach water and sewer utility, and therefore are paid ahead of any debt service.

Norfolk also provides service to the City of Chesapeake (utility system rated 'AA', with a Stable Outlook), and the U.S. Navy. Service to Chesapeake consists of a small amount of treated water (2.2 mgd in 2011) and a larger amount of surplus raw water (7.1 mgd in 2011) on a take-or-pay basis. Revenues from Chesapeake accounted for about 9% of total revenues in 2011, while the US Navy comprised 11%. The contract with the US Navy is a short-term contract that expires later this year. Management expects an extension of this contract for another three-year term.

System Capacity is Strong

Water supplies are extensive and diverse, consisting of a series of eight city-owned surface water reservoirs totaling 15.2 billion gallons in storage capacity. In addition, supply comes from Lake Gaston, a Virginia Beach-owned water source, and two supplemental sources consisting of intakes from the Blackwater and Nottoway rivers. Four deep groundwater wells (located in Suffolk) are also available during dry periods. The city estimates it has enough supply to serve the needs of the region for another 50 years. Two water treatment facilities have a current capacity of 136 mgd, which is more than twice the average daily demand in 2011.

Stable Financial Performance and Management

The system's stable financial profile is evidenced by strong historical financial margins and good debt service coverage. Operating margins ranged between 47% and 55% over the past five fiscal years, which is considered strong. However, the system annually transfers over $8 million to the city's general fund as an annual return on investment, which limits the amount of free cash flow available for capital spending. The annual transfer, while not unusual for a utility system, is high at roughly 10% of annual revenues.

Management expects to update various financial and other policies over the next 12 months; however a change to the annual transfer is not anticipated. For the past five years the system has generated between 1.5x and 1.8x coverage on the senior bonds, which is below average for the rating. However, Fitch is comfortable with these coverage levels given the hybrid nature of the system, its regional importance, and strong liquidity.

Including subordinate lien GO bonds, all-in coverage has been slightly lower. Rate increases have helped improve revenue performance over the past two fiscal years, leading to slightly better coverage in FY 2010 of 1.8x. In FY 2011 coverage was closer to 1.7x due to a slight increase in debt service.

The system's balance sheet resources (liquidity) are strong despite large annual transfers to the general fund. Including operating reserves, repair and replacement fund balances, rate stabilization funds, and the unrestricted general reserve, the system had 442 days cash on hand as of fiscal end 2011. Other important liquidity ratios (such as working capital and current ratio) are also above average. A strong liquidity profile provides significant financial flexibility, which in addition to the partially wholesale nature of the system, helps mitigate below average debt service coverage.

Manageable Debt Position Expected to Continue

After issuance, the system will have approximately $300 million in senior lien parity debt outstanding. The refunding is expected to provide significant net present value savings of over 20% of the refunded par. Most of the savings will occur over the next five years, and maturities are not being extended.

Debt as a percentage of net plant assets is 77% for fiscal 2011; however, debt per capita, which takes into account the entire service area population served by Norfolk, is roughly $350, and is in line with the rating level. In addition, when including the retail customers Norfolk serves indirectly through its large wholesale contracts, debt per customer was just $1,319 in 2011, which is slightly below the median ($1,615) for 'AA' rated systems.

Principal amortization is average, with 40% of principal retiring within 10 years and 82% retiring in 20 years. The approximately $100 million five-year capital program is expected to be mainly funded with additional debt; however Fitch projects the debt burden will remain manageable. Projects will focus on water line replacement and rehabilitation and treatment plant upgrades. Management expects to issue bonds in fiscal 2013, and again in fiscal 2015.

Competitive Rates Expected to Continue to Rise Automatically

Retail rates are set by the city council and are reviewed annually during the budget process. After double-digit rate increases in 2004 and 2005, rate increases have been moderate at approximately 3.5% annually. In 2011, residential rates for 1,000 cubic feet of use per month (about 7,500 gallons) were competitive relative to other regional utilities at $40, which is roughly 1.1% of median household income. Rates are expected to remain competitive despite automatic annual increases designed to provide for baseline revenue growth.

Legal Provisions are Below Average, Changes to Reserve Funding

The city covenants to establish, fix, charge, and collect rates, fees, and charges, and revise such rates fees and charges when necessary so that in each fiscal year net revenues are at least equal to the greater of 1.1x annual debt service for senior bonds plus 1.0x coverage for subordinate bonds, or 1.0x the funding requirements for the various funds of the indenture, including the bond fund, debt service reserve, and renewal and replacement. To issue additional bonds, adjusted net revenues received during any 12 consecutive of the previous 24 months must meet the rate covenant.

The city will make a change to the requirement for the funding of debt service reserve funds with the issuance of the 2012 bonds. The original debt service reserve fund is common to all outstanding bonds (and will remain intact as long as the parity bonds are outstanding). The current cash balance in the existing debt service reserve is about $8 million.

Going forward debt service reserve funds will be series-specific and the city will have the option whether or not to fund a reserve for a particular series of bonds, and to what level. For the 2012 bonds, the city has determined it will not fund a debt service reserve. While this weakens already below average covenants, the system retains a sizable cash position, has the ability to raise rates, and is generally well managed. As a result, Fitch does not believe the exclusion of a debt service reserve for the 2012 bonds materially weakens the system's strong overall credit profile.

Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

In addition to the sources of information identified in Fitch's Revenue-Supported Rating Criteria, this action was additionally informed by information from CreditScope.

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria' (June 20, 2011);

--'U.S. Water and Sewer Revenue Bond Rating Criteria' (Aug. 10, 2011);

--'2012 Water and Sewer Medians' (Dec. 8, 2011);

--'2012 Water and Sewer Sector Outlook' (Dec. 8, 2011).

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=637130

U.S. Water and Sewer Revenue Bond Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647331

2012 Water and Sewer Medians

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=657111

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