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Fitch Rates Metropolitan Water District of Southern California's $81.8MM Water Revs 'AA+'

Posted on: Friday, 2 November 2007, 18:00 CDT

Fitch Ratings has assigned an 'AA+' rating to Metropolitan Water District of Southern California's (Metropolitan) $81.875 million water revenue refunding bonds, series 2007B.

The bonds will be structured as auction-rate securities and are scheduled to sell via negotiated sale on Nov. 13, 2007. Broker dealers for the bonds include Banc of America Securities LLC and Morgan Stanley. The bonds will be insured by XL Capital. Bond proceeds will be used to refund a portion of Metropolitan's outstanding 1997 Authorization, Series A bonds, fund a debt service reserve fund for the 2007 Series B bonds, and pay costs of issuance.

Fitch also affirms the 'AA+' long-term rating on Metropolitan's approximately $4.3 billion in outstanding water revenue bonds and the 'AAA' long-term rating on Metropolitan's approximately $359 million of general obligation (GO) bonds. The Rating Outlook on all the bonds is Stable.

Revenue bonds are secured by net operating revenues of Metropolitan's water system. GO bonds are secured by Metropolitan's ability to levy ad valorem taxes on its $1.8 trillion tax base at rates necessary to cover debt service on the bonds.

The 'AA+' rating reflects credit strengths that include the essentiality of the service provided, Metropolitan's role as the region's wholesale water supplier, a strong financial position even with a recent decline in debt service coverage levels, long-term financial and operational planning practices, and a robust, diverse and growing service area. Credit concerns focus on recent legal challenges to the operation of the State Water Project (SWP) that may significantly reduce Metropolitan's largest water supply and sizeable capital costs related to long-term water supply, storage and treatment costs. Cost pressure on both the operating and capital costs at Metropolitan could prompt higher rate increases than had previously been expected. Metropolitan has revised initial rate increase projections for the next couple of years from the 3-6% range annually to 9-10%. Rates are set on a calendar year basis. Historical increases in the last couple of years have been in the 5-6% range. However, these were kept lower than the actual cost increases through Metropolitan's use of its rate stabilization fund and a reduction in margins.

Metropolitan provides between 40% and 60% of the service area's water, depending on water conditions, and works with the California Department of Water Resources (DWR) on the development and acquisition of long-term water supply for the region. Metropolitan's supply is derived from two sources - Northern California's Bay/Delta water via the SWP, which provided approximately 75% of its water supply in calendar 2006, and the Colorado River via the Colorado River Aqueduct, which provided the remaining 25%.

Following reductions to the Colorado River supply in recent years due to a settlement in 2003 among all California parties that use water from the river, the SWP has become an increasingly important component of Metropolitan's overall water supply. The result of a recent legal decision has the potential to reduce Metropolitan's allocation from the SWP by up to 30%, which could significantly impact Metropolitan's water supply under certain conditions. This legal case is occurring within a broader political debate in California regarding the Bay/Delta and the numerous environmental impacts affecting the Bay/Delta, including urban development, farming practices, deteriorating levy conditions, flood control, and state water consumption demands. The reduction of SWP water would be a negative credit development for Metropolitan and its members.

The actual reductions in water supply will depend in large part on weather conditions and the health of protected fish in the Bay/Delta. Operations of the SWP may be changed again resulting from the development of a new biological opinion in 2008, required as part of an ongoing federal lawsuit challenging operations of the SWP. Mitigating this concern is Metropolitan's actions to reduce demand, such as curtailment of water sales for groundwater recharge and a 30% reduction to agricultural customers, the use of stored reserves, and efforts to increase supplies from other sources. In addition, Metropolitan has invested over the last decade in the construction of local storage capacity and new water exchange and banking projects to provide additional reliability in the region upon the occurrence of a seismic event that could disrupt imported water supplies or prolonged drought conditions, such as those experienced across California this past year. Although these storage agreements were designed to protect against short-term events, they provide some protection against the potential long-term reduction in water supply from the SWP. Current storage in the region is in excess of Metropolitan's annual demand.

Financial performance in fiscal 2007 was in line with expectations. Debt service coverage of all obligations of 2.21x and fixed charge coverage of 1.69x has declined slightly from coverage in previous years. The decline is the result of increased SWP costs, debt service costs associated with the capital plan, and rate increases that were not designed to accomplish full recovery of those increased costs. Metropolitan's five-year capital investment plan (CIP) totals $1.6 billion. Over the next five years, Metropolitan expects to add another $560 million to its current $4.3 billion in outstanding debt. Debt service coverage is projected to range between 1.65x and 2.3x over the next five years. Fitch views the projected decline in debt service coverage as acceptable for the current rating, given Metropolitan's fundamental credit strengths, the temporary nature of the declines (a return to over 2.0x debt service coverage is projected by Fiscal 2010), and the board's history of demonstrated support for cost recovery through rates, when necessary.

Metropolitan is a wholesale water provider to 26 member public agencies. Its vast service area includes over 18 million residents, or about 85% of the population in Los Angeles, Orange, Riverside, San Bernardino, San Diego, and Ventura counties. While member agencies are not required to purchase Metropolitan's water, Fitch does not view competition as a credit concern given the practical lack of other supplies.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.

Source: Business Wire

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