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SAN FRANCISCO--([ BUSINESS WIRE ])--Fitch Ratings assigns the following ratings to the Metropolitan Water District of Southern California, CA (Metropolitan):

--Approximately $60 million water revenue refunding bonds, series 2012F 'AA+';

--$47.3 million water revenue refunding bonds, series 2004 A-1 bank bonds 'AA+';

--$47.3 million water revenue refunding bonds, series 2004 A-2 bank bonds 'AA+'.

The series 2012F bonds are being issued as fixed rate bonds. Proceeds will refund outstanding fixed and variable rate obligations of Metropolitan and pay costs of issuance. The bonds do not have a debt service reserve fund. Fitch is assigning bank bond ratings to the series 2004 A-1 and A-2 bonds, which are being remarketed in connection with the substitution of the standby bond purchase agreement (SBPA). The series 2004 A-1 and A-2 bank bond ratings reflect the underlying rating on the bonds, in the event they become bank bonds. Fitch expects to assign a rating on series 2004 A-1 and A-2 bonds based on the SBPA liquidity support closer to the bond closing.

At this time, Fitch also affirms the following ratings on Metropolitan's existing debt:

--$4.5 billion outstanding water revenue bonds at 'AA+';

--$535.8 million outstanding water revenue refunding bonds, series 2009A-1, 2009A-2, 2011A-1, 2011A-2, 2011A-3, 2011A-4, 2012B-1, and 2012B-2 (SIFMA index mode) at 'AA+'/'F1+';

--$58.2 million outstanding water revenue refunding bonds, series 2012E-1 and 2012E-2 (term mode) at 'AA+'/'F1+';

--$31.2 million outstanding water revenue refunding bonds, series 2012E-3 (term mode) at 'AA+';

--$100.7 million outstanding special variable rate water revenue refunding bonds, series 2010A (variable rate self-liquidity) at 'AA+'/'F1+';

--$196.5 million outstanding waterworks general obligation (GO) bonds at 'AAA'.

The Rating Outlook on all bonds is Stable.

SECURITY

WATER REVENUE BONDS: Revenue bonds are secured by net water revenues of the district.

VARIABLE RATE SELF LIQUIDITY: The 2010A bonds are outstanding as variable rate demand bonds in the weekly mode. Payment of scheduled principal and interest on the bonds is secured by a net operating revenue pledge on parity with Metropolitan's revenue bonds. Payment of the purchase price of a tender (either optional or mandatory) is secured solely by a subordinate pledge of net revenues.

SIFMA INDEX AND TERM MODE BONDS: The 2009A-1, 2009A-2, 2011A-1, 2011A-2, 2011A-3, 2011A-4, 2012B-1, and 2012B-2 bonds are outstanding in the index mode. The 2012E-1, 2012 E-2, and 2012 E-3 bonds are outstanding in the term mode with a fixed interest rate until the mandatory tender date. Payment of scheduled principal and interest on the bonds is secured by a net operating revenue pledge on parity with Metropolitan's water revenue bonds. Payment of the purchase price of a tender (either optional or mandatory) is secured by a subordinate pledge of net revenues.

NO CROSS DEFAULT: A failure by Metropolitan to provide sufficient proceeds to pay the purchase price of the SIFMA index, term mode bonds, or the self-liquidity 2010A bonds at the tender date would not constitute an event of default on Metropolitan's revenue or GO bonds.

GO BONDS: The GO bonds are secured by an unlimited ad valorem tax on all property within the district.

KEY RATING DRIVERS

WHOLESALE SUPPLIER: Metropolitan is the supplemental wholesale water supplier to 18 million people in southern California. Water is provided from two major supply sources that have experienced some variability. Revenues are provided from 26 member agencies that exhibit strong credit quality.

ADEQUATE FINANCIAL PROFILE: Financial metrics are low for the rating but typical for a wholesale agency with additional financial strength provided by the members and timely rate recovery. Financial performance in fiscal 2012 is improving and the district expects coverage to comply with the board adopted financial policies.

ADAPTING TO LOWER SALES: Water sales declined 29% over fiscal years 2009 - 2011, causing a direct impact on district revenues. Sales may remain at this lower level given ongoing conservation in the region and development of alternative local supplies. Metropolitan is taking steps to adjust its rate setting to reflect lower sales.

RATE FLEXIBILITY: Metropolitan's revenue flexibility is evident in the 75% cumulative rate increases over the recent six-year period, although rate sensitivity is likely heightened given the magnitude of recent rate actions. The board recently approved additional rate increases of 5% per year effective in fiscals 2013 and 2014.

LIMITED EXPENDITURE FLEXIBILITY: Expenditure flexibility is limited given Metropolitan's relatively high fixed costs associated with its water supply and debt service requirements. Fitch recognizes the budget cushion created by the district through the inclusion of pay-as-you-go capital appropriations and reserves designated to absorb weather related demand fluctuations.

COMPLEX DEBT PORTFOLIO: Metropolitan's debt portfolio continues to require careful management and attention, given its complexity and the prominence of multi-modal and swap transactions.

SIFMA INDEX AND TERM MODE BONDS: The 'AA+'/'F1+' rating on the SIFMA index and term mode bonds reflects the market access implied by the Metropolitan's long-term credit quality.

SELF LIQUIDITY VARIABLE RATE DEBT: The 'AA+'/'F1+' rating on the series 2010A self-liquidity bonds, outstanding in the weekly mode, reflects the liquidity provided by Metropolitan's $325 million in unrestricted and undesignated cash as of July 31, 2012.

GO BONDS: Metropolitan's 'AAA' GO rating is based on its ability to levy unlimited ad valorem taxes on its sizable $2 trillion tax base, with the property tax revenues restricted to be used only for debt service on the GO bonds and capital costs related to the State Water Project (SWP).

CREDIT PROFILE

Metropolitan is a wholesale water supplier in a large and diverse six-county area in southern California to 26 member agencies. Many of Metropolitan's members have some limited form of local water supply and, given the significant cost increases in Metropolitan's supply, are investing in alternative supplies to reduce water purchases from Metropolitan, when economical.

FINANCIAL PERFORMANCE STABILIZING AFTER FISCAL 2011

Metropolitan's financial position is healthy, despite a trend of declining financial margins between 2006 and 2011. Financial performance reached an exceptionally low level in fiscal 2011, primarily resulting from only 1.63 million acre feet (maf) of water sales as compared to the budgeted amount of 1.93 maf. Debt service coverage, excluding one-time revenues, was 1.35x on revenue bonds and 0.94x coverage on all payment obligations. Metropolitan used $61 million from its rate stabilization fund, which improved debt service and all payment obligation coverage levels to 1.57x and 1.09x, respectively.

Metropolitan's financial performance improved in fiscal 2012 even though water sales continued to be low at 1.68 maf. For fiscal 2012, a 7.5% rate increase became effective mid-year 2012 and expenditure reductions in areas such as conservation spending, water delivery costs, and power expenses helped to increase net revenues. Debt service coverage of revenue bonds at the end of fiscal 2012 was 1.81x, with fixed charge coverage of 1.31x.

PLANNING ASSUMPTIONS ANTICIPATE CONTINUED LOW WATER SALES

Metropolitan is assuming between 1.7 maf - 1.75 maf in water sales in future years, which represents lower forecasted sales than used by Metropolitan for financial planning and rate setting in previous years. While this represents a reasonable planning assumption given sales of 1.63 maf sold in fiscal 2011 and 1.68 maf in fiscal 2012, the sales in fiscal 2012 included a large amount of replenishment sales (225,000 af), which may not reoccur in fiscals 2013 and 2014. Metropolitan remains well positioned with its water storage and water supply rights to meet a substantially higher demand from its members, should it occur. The ongoing uncertainty in water sales presents some level of risk to revenues, given Metropolitan's highly volumetric rate structure and largely fixed expenditures.

With the relatively flat assumed water sales, improvement in financial performance relies on rate increases and expenditure reductions. In April 2012, the board adopted rate increases of 5% for the next two calendar years. This was the lowest of the three staff proposals, reflecting rate sensitivity among the member agencies given the sizable rate increases to date. The lower revenues than those provided in the other rate options will be mitigated in the budget through lower spending on storage programs, staffing, and equipment replacement. Debt service coverage for fiscal 2013 is projected to remain around 1.63x while the fixed charge coverage is anticipated at 1.15x. The 'AA+' rating assumes that Metropolitan will generally operate, at a minimum, at or above this level of financial performance. Given the cyclicality of demand, certain years will likely generate stronger metrics.

CASH RESERVES FOR RISK

Metropolitan continues to have a degree of financial flexibility provided by its cash reserves, with the rate stabilization fund at $332 million as of June 30, 2012. However, reserves are used to mitigate other risks, such as providing self-liquidity for $100 million in variable rate bonds and $50 million reserved against potential litigation costs with the San Diego County Water Authority (SDCWA). To the extent the litigation is decided in favor of SDCWA and Metropolitan must make a payment to SDCWA, Fitch anticipates that any settlement would be collected from other rate categories in a timely manner. The litigation relates to Metropolitan's rate methodology used to allocate costs between members. Although it is not surprising to have customer equity issues arise regarding rate-setting at such a large wholesale agency with so many members, Fitch views the increasing tension between the two entities as a potential credit concern.

REGIONAL SUPPLY CHALLENGES RESULT IN LOWER WATER DEMAND FROM MEMBERS

The previous five years have brought significant developments to the water supply mix in Metropolitan's service area and the demand profile from members for Metropolitan's water. Drought conditions and regulatory changes to pumping on the SWP have prompted Metropolitan and its members to work together to develop new local supplies that will reduce the regional demand in Southern California for imported water sold by Metropolitan.

The significant increases in Metropolitan's water rates to its members over the past six years have made local alternatives cost effective that had previously not been considered viable.

Metropolitan's members are not required to buy minimum amounts of water from Metropolitan but instead use the imported water supply to supplement existing and new local sources. In addition, Metropolitan's rate structure is heavily weighted towards volumetric pricing, so fluctuations in demand have a direct impact on revenues.

Metropolitan's role in the region is crucial in that it supplies 40% - 60% of Southern California's water supply in six counties with a service area population of 18 million. As the high cost provider, Metropolitan absorbs much of the regional demand variability due to conservation and efficiency investments as well as economic pressures. Although a regional economic recovery may increase demand, Metropolitan's members are required to meet a legislative requirement to reduce per capita usage by 20% in 2020, so investments in recycling and conservation may continue to place longer-term downward pressure on Metropolitan's water sales and revenue base.

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.

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria' (June 12, 2012);

--'U.S. Water and Sewer Revenue Bond Rating Criteria' (Aug. 3, 2012);

--'Tax-Supported Rating Criteria' (Aug. 14, 2012);

--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 14, 2012);

--'Criteria for Assigning Short-Term Ratings Based on Internal Liquidity' (June 15, 2012);

--'Rating U.S. Municipal Short-Term Debt' (Dec. 8, 2011);

--'Metropolitan Water District of Southern California' (April 26, 2012).

For information on Build America Bonds, visit [ www.fitchratings.com/BABs ].

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=681015 ]

U.S. Water and Sewer Revenue Bond Rating Criteria

[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=684901 ]

Tax-Supported Rating Criteria

[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015 ]

U.S. Local Government Tax-Supported Rating Criteria

[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314 ]

Rating U.S. Municipal Short-Term Debt

[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=659234 ]

Metropolitan Water District of Southern California

[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=676383 ]

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