Fitch Affirms North Carolina State Ports Authority Revs at 'BBB+'; Outlook Stable

Fitch Ratings affirms its 'BBB+' rating on approximately $42 million in North Carolina State Ports Authority's (the authority) revenue bonds, series 2010A and 2010B. The Rating Outlook is Stable.

Additionally, the authority has $20 million in outstanding subordinate revenue bonds and $30 million in junior lien capital equipment leases that are not rated by Fitch. The subordinate revenue bonds are currently in the process of being refunded.

KEY RATING DRIVERS

Regional Port Service with Reliance on Bulk and Breakbulk: The port system primarily serves its regional base coupled with access to other economic growth corridors which provide some stability to operations. From a product standpoint, there is reliance on bulk and breakbulk cargoes for the majority of volume throughput with an elevated level of concentration risk in wood/forest- and phosphate-based cargo. Exposure to the extremely competitive southern Atlantic port environment, of which the North Carolina ports have a relatively small market share position, remains a concern. However, volumes have shown resilience in recent years, and the diversity of trading partners and import/export exposure is adequate. Revenue Risk: Volume - Weaker

Growth-Dependent Profile with Limited Downside Protection: The authority's projections are somewhat dependent upon top-line revenue growth over the next decade in order to maintain strong margins and coverage levels. Given the port's status as an operating port with moderate levels of contractually obligated payments (between 10% and 20% of revenues), the port system remains exposed to cash flow volatility associated with economic cycles and fluctuations in commodity prices. Revenue Risk: Price - Midrange

Modest Capital Plan with Some Potential for Additional Leverage: The current capital program is modest at $156 million and is funded with a mix of grants and port revenues. While port leadership is in a transitional stage which could lead to some reassessment of needs, there is some potential for additional leverage in the future to support the market-driven capital program. The timing and magnitude of the borrowing will depend on market demand for various projects. Infrastructure Development/Renewal - Midrange

Moderate Debt Structure: Stable amortizing debt structure, with some variable rate exposure. The authority has an internal policy to maintain debt to equity levels to a maximum of 50% (currently 44%), and targets variable rate debt at a 15%-20% range of the total portfolio (currently 22%, expected to fall to 21% post-refunding). Covenants are adequate, with a senior rate covenant of 1.35x and an all-in covenant of 1.05x. The authority is in the process of refunding $20 million in 2008 bonds, with the principal paydown schedule expected to be largely unchanged. Debt Structure - Midrange

Strengthening Financial Profile: The authority has a history of somewhat volatile but generally satisfactory operating and financial performance, with debt service coverage ratios of 1.5 times (x) or better on an all-in basis in recent years, improving to 2.3x in fiscal 2013. Net debt levels are moderate relative to cashflow (6.3x net debt/cash flow available for debt service), and liquidity is moderate at 187 days cash on hand.

Rating Sensitivities

--While port leadership is in a transitional stage, continued prudence in timing of demand-driven expansion projects in the capital program and maintenance of leverage at levels are relevant to rating maintenance;

--Ability to maintain 2.0x debt service coverage on senior lien obligations and 1.5x on an all-in basis. Lower coverage levels could signal rating pressure;

--The authority's ability to realize forecasted growth rates for volumes and revenues would support rating stability.

SECURITY

The bonds are secured by net revenues after the payment of operating and maintenance expenses. The deep-water ports in Morehead City and Wilmington generate most of the cargo operations and operating revenues.

CREDIT SUMMARY

Fiscal 2013 saw operating revenues increase 12% to over $44 million. Year to date 2014 has seen a 2% decrease thus far. Revenue gains in 2013 reflect increases in cargo volumes due to increased importation of grain. The five-year compound annual growth rate (CAGR) since 2008 indicates an increase of just above 2%.

Cargo volumes have been volatile over the past several years, largely driven by market shifts in key commodities handled at both ports. At the Wilmington port facility, there was a nearly 20% increase in breakbulk volumes for 2013 which followed overall declines in breakbulk tonnage since 2006. With regards to bulk volumes, a 50% increase in bulk volumes for 2013 followed an 86.2% increase in the prior year, bringing bulk tonnage to a new high relative to historic levels. In the container segment, there was a 3.1% decrease in container units on a 20 foot equivalent (TEU) basis in 2013, after a decrease of 4.9% in 2012. The blended CAGR for the past five years for Wilmington overall reflects growth of 8.9% on a tonnage basis.

After three years of positive breakbulk growth for Morehead City Port through fiscal 2012, 2013 saw a slight tonnage decrease of 0.5%. Similarly, Morehead bulk volumes saw growth in fiscal 2011 and 2012, followed by a decrease of just under 19% in 2013. The port's total tonnage decreased 16.9% in 2013. Morehead's overall CAGR for the past five years is negative 0.8%. On a combined basis, Wilmington and Morehead saw growth of 8.6% on a tonnage basis for 2013, and the tonnage CAGR since 2007 has been 5.9%. For the first four months of fiscal 2014 through October, tonnage is up 0.8% over the same period in fiscal 2013.

As of July 2013, guaranteed cargo provisions covered $2.85 million in contractually obligated payments, similar to 2012. Combined with non-cancellable leases, guaranteed revenues total around $7 million, or 16% of 2013 revenue, which is modest compared to other Fitch rated seaports. This lower level of minimum annual guarantees (MAGs) can lead to more volatile revenue performance in periods of reduced cargo throughput; however, the balance of bulk, breakbulk, and container cargos provides some diversification and balance. Further, the authority maintains a conservative operating reserve policy of $10 million, which provides financial stability in the event of cash flow disruptions or event-related occurrences.

The authority has also demonstrated its ability to contain operating expenses to preserve financial health. Operating expenses declined in all but two years between 2006 and 2013, with 2013's increase tied largely costs related to increased cargo activity. Operating expenses have shown a 1.5% CAGR over the past five years. Operating margins have held steady in the 20%-25% range in recent years, rising to 29% in 2012 and 2013. Fiscal 2014 year to date through October has seen operating expenses up 0.7% over the same period in 2013.

Historically, the authority's net revenues have been sufficient to provide comfortably high levels of coverage, with senior lien debt service coverage of 3x or higher, and total debt service coverage including senior, subordinate, and equipment lease obligations of 1.45x or higher. Debt service obligations in absolute terms have been relatively low historically, with total aggregate annual requirements not exceeding $5.9 million per year (includes $2 million per year of equipment lease obligations). Additional senior lien bond issuances have been deferred, and management indicates no additional borrowing will proceed without revenue contracts in place for the related demand-driven projects. However, should the authority proceed with additional issuances on the senior lien, total annual obligations may increase by the end of the decade.

Fitch notes the authority's flexibility in timing of capital projects, specifically in the outer years given the sufficient capacity to handle current and future demand, and expects projects to continue to be deferred if volume does not materialize. Thus, additional leverage is expected to parallel growth trends in the authority's operating revenues. Nonetheless, Fitch views that the debt service coverage ratios on the senior lien and on an all-in basis could narrow as compared to historical performance should volume and revenue grow more slowly than forecast. The port has an internal policy to maintain over 2.0x debt service coverage on its senior lien and a 1.5x on an all-in basis. Under Fitch's base case scenario, which considers 2% growth in operating revenues and expenses through 2017 (consistent with the growth rates observed over the last five years), coverage is expected to remain at 1.8x or better on an all-in basis. Fitch will monitor these policies and strategic directions considering the leadership changes currently underway at the authority.

The authority's capital plan is currently estimated at approximately $156 million, lower than the previous year. Capital investment for fiscal year 2014 is also projected to be lower than the preceding year, coming in at approximately $12 million. Funding for these expenditures will be accomplished, as in recent years, by a combination of state capital aid, federal grants, and internal cash flows. While no new money issuances are currently scheduled, the authority is in the process of refinancing its subordinate 2008 bonds for savings. The paydown schedule is expected to be largely unchanged from that of the existing bonds, and the bonds will held entirely by BB&T with a seven-year commitment from the bank.

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

Applicable Criteria and Related Research:

--Rating Criteria for Infrastructure and Project Finance (July 12, 2012);

--Rating Criteria for Ports (Oct. 3, 2013).

Applicable Criteria and Related Research:

Rating Criteria for Infrastructure and Project Finance

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=682867

Rating Criteria for Ports

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=719985

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=813772

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