Fitch Assigns Unenhanced 'AA' Rating to California DWR's Ser 2002 Power Supply Revs; Outlook Stable

NEW YORK--(BUSINESS WIRE)--Fitch Ratings assigns an underlying long-term rating of 'AA' to the following California Department of Water Resources' (DWR) outstanding variable-rate power supply revenue bonds:

--$25 million, series 2002B-6;

--$79.2 million, series 2002C-1;

--$246.9 million, series 2002C-4;

--$100 million, series 2002C-9;

--$15.4 million, series 2002C-10;

--$59.6 million, series 2002C-11;

--$58.1 million, series 2002C-14;

--$20.8 million, series 2002C-17.

The Rating Outlook is Stable.

Fitch is assigning an unenhanced rating to the noted 2002 bonds which are currently supported by bank-provided letters of credit (LOCs). The LOCs expire on Nov. 30, 2010 and DWR will be substituting the credit facilities with liquidity facilities (in the form of standby bond purchase agreements) effective as of Nov. 19, 2010. Fitch will be assigning a rating to the planned reoffering of the affected 2002 bonds later today, which takes into account the substituted enhancement facilities.

SECURITY:

The power supply revenue bonds are secured by DWR's Electric Power Fund bond charge revenues, imposed by the California Public Utilities Commission (CPUC) on approximately 11.5 million electric customers served by the state's largest investor owned utilities: Pacific Gas & Electric Co. (PG&E; Fitch Issuer Default Rating [IDR] of 'A-'), Southern California Edison Co. (SCE; IDR of 'A-'), and San Diego Gas & Electric Co. (SDG&E; IDR of 'A+'). The bonds are separately secured from any other obligations of DWR and are not obligations of the State of California.

RATING RATIONALE:

--DWR's power supply revenue bonds' high quality rating reflects the solid eight-year track record of timely processing of DWR's annual revenue requirement by the CPUC, maintenance of solid operating and debt service reserves, and substantially reduced variable-rate debt exposure with the recent 2010M refunding issuance.

--The long-term rating further reflects DWR's rapidly declining power supply costs, particularly beginning in 2012. The diminishing power supply cost is a key credit positive, as the power supply portion of DWR's charges has historically been the more volatile component, due to associated natural gas commodity exposure and volume (kwh sales) risk.

--The rating is also supported by the irrevocability and enforceability of the bond charges, the solid credit strength of the state's IOU's and the diversity of their large customer base (11.5 million), which is required to make payments to DWR for its power supply and bond charges. The bond charges are further required by state statute (AB1X) to be adjusted as needed to fully cover DWR's debt service costs.

--In the past, DWR's heavy utilization of variable-rate debt has been a credit concern (historically in excess of 50% of total debt was variable rate). With the recent 2010M refinancing, DWR's remaining variable rate debt outstanding (at less than $1 billion) will account for roughly 11% of total debt.

--A credit concern noted in our last review of DWR (April 2010) was the substantial ($3.6 billion at the time) amount of bank provided letters of credit and liquidity facilities, supporting the variable-rate debt, which were due to expire by Dec. 1, 2010. This material refinancing /replacement risk has been substantially addressed via a combination of replacement bank facilities (two years duration) and refinancing of portions of variable-rate debt to fixed-rate debt (2010M bond proceeds).

--Credit concerns appear manageable and include risks to transaction cash flows due to excessive volatility of power/fuel prices in California and any delays in the CPUC's adoption of proposed changes to the revenue requirement, neither of which has hindered DWR's performance to date.

--It is important to note, that DWR's operating cash reserve levels will decline as the power charge component of DWR's bill diminishes. While this decline in cash reserves is a credit concern, it is largely offset by the commensurate reduction in the more volatile power supply portion of DWR's charges.

KEY RATING DRIVERS:

--DWR's credit strength is predicated on its continued ability, and that of the CPUC, to process DWR's annual revenue requirement on a timely and adequate cost recovery basis.

--DWR's stable credit outlook incorporates its ability to maintain adequate operating and debt service reserves.

--Lastly, any material legislative change affecting DWR's ability to adequately pass through the bond and power supply charges would be an event risk that would trigger rating action.

CREDIT SUMMARY:

DWR's Electric Power Fund was created by state legislation in 2001 when soaring energy prices outpaced the capped retail electric rates charged by the state's IOUs, rendering PG&E and SCE unable to pay their full power expenses and comprising the ability of all three IOUs to reliably deliver power to its customers. Governor Davis at the time declared a state emergency in California, and directed the DWR to take over the responsibility to procure power for the state's three largest IOUs. Toward this endeavor, DWR issued over $11 billion in power supply revenue bonds, with roughly 60% fixed- and 40% variable-rate securities initially.

In 2001-2002, DWR also entered into a series of short- and long-term power supply contracts to meet the portion of retail load that the IOUs could not meet. Over the years, DWR very conservatively stress tested its natural gas exposures on those contracts, and regularly updated sales and natural gas price forecasts to maintain adequate recovery of power supply costs in its power charges to the customers of the IOUs. By 2008, the power supply contracts had begun to expire, modestly reducing DWR's power supply risk. In 2010, the decline in the power supply expense rapidly accelerates until DWR's power supply costs amounts to a minimal $16 million by fiscal year 2015 - a very modest power supply exposure.

With respect to the bond charge revenues, DWR experienced some volatility in variable-rate interest expense during the financial market fallout beginning in 2007-2008. Positively, DWR comfortably weathered the auction- and variable-rate market turmoil given its significant operating and debt service reserves. In addition, DWR benefitted from its very conservative variable interest-rate projections (incorporated into its annual revenue requirement filing with the CPUC). Also, DWR forecasted its interest rate cost for unhedged variable-rate securities in the 4%-5.7% range - or roughly 400-500 bps above the variable rate of interest actually experienced. DWR's recent revenue requirement filing with the CPUC, for fiscal year 2011, continues to maintain very conservative key assumptions, including an average variable interest rate of 4.017% and natural gas prices in the $5-$6 per MMBtu range for fiscal year 2011.

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

Applicable Criteria and Related Research:

--'Revenue Supported Rating Criteria', dated Oct. 8, 2010;

--'Public Power Rating Guidelines', dated June 11, 2009.

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=564565

Public Power Rating Guidelines

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=447150

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