OREANDA-NEWS. Fitch Ratings has assigned its 'AA+' rating to the following bonds issued by the Metropolitan Water District of Southern California (Metropolitan):

--Approximately $213 million water revenue bonds, 2015 Authorization series A.

Bond proceeds will fund Metropolitan's capital needs in fiscal 2016. Bonds are expected to price on Dec. 10, 2015.

In addition, Fitch affirms the following ratings:

--$3 billion outstanding water revenue bonds and term bonds at 'AA+';
--$536.4 million SIFMA index mode bonds, series 2009A-2, 2011A1-A4 and 2012B1-B2; and flexible index mode bonds, series 2013E at 'AA+'/'F1+';
--$339.9 million special variable rate water revenue refunding bonds, series 2013D, 2014D and 2015A (self-liquidity)at 'AA+'/'F1+'; and
--Bank bond rating on series 2008A-2 at 'AA+'.

The Rating Outlook is Stable.

SECURITY

Bonds are payable from net water revenues of the district, which are on parity with approximately $4 billion in outstanding water revenue bonds.

KEY RATING DRIVERS

WHOLESALE SUPPLEMENTAL WATER SUPPLIER: Metropolitan is the supplemental wholesale water supplier to 18.45 million people in southern California. Revenues are provided from 26 member agencies that rely on water purchased from Metropolitan to supply their retail customers, although there are no minimum annual purchase or payment amounts.

LOWER FINANCIAL MARGINS IN 2016: Financial margins are expected to dip in fiscal 2016 as water sales are below already low budgeted levels. Debt service coverage is expected to dip to 1.38x on revenue bonds or 1.14x fixed charge coverage, below Metropolitan's financial policy target of 1.2x fixed charge coverage. Metropolitan has spent down some of its robust reserves on conservation programs but levels remain adequate.

VARIABLE SALES DRIVE FINANCIAL MARGINS: Financial performance exhibits a high degree of cyclicality as compared to retail water utilities as a result of Metropolitan's role as the supplemental supplier and its highly volumetric rate structure. Financial margins are dependent on the volume of water sales achieved in any given year, which have fluctuated considerably in the past 10 years.

RATE FLEXIBILITY EXISTS: Fitch views Metropolitan's rate flexibility as relatively strong given the large increases between 2008 and 2013 and continued modest annual increases in recent years. Nevertheless, some rate sensitivity and limitations exist given the varied reliance on Metropolitan by its purchasers and an ongoing lawsuit with San Diego County Water Authority (SDCWA) regarding Metropolitan's rate structure.

WATER SUPPLY FLUCTUATIONS: Water is primarily provided from two independent supply sources. Supply fluctuations occur on both supplies - the State Water Project (SWP) and the Colorado River. Metropolitan's substantial storage facilities help balance this risk.

SELF-LIQUIDITY VARIABLE-RATE DEBT: The 'F1+' rating on the self-liquidity bonds reflects the liquidity provided by Metropolitan's $623.5 million in unrestricted cash and operating and maintenance reserve as of Oct. 31, 2015 and liquidity provided by $276.5 million in revolving credit facilities, together covering the authority's maximum daily exposure to un-remarketed puts by over 1.25x.

RATING SENSITIVITIES

SUSTAINED PRESSURE FROM DROUGHT: Fitch's 'AA+' rating and Stable Outlook anticipate a degree of cyclicality in Metropolitan's coverage and reserve levels. However, multiple years of sustained lower coverage and/or reserve levels could pressure the rating.

CREDIT PROFILE

Metropolitan is a wholesale water supplier in southern California to 26 member agencies, many of whom have some form of local water supply. The largest three members (54% of water revenues in 2015) are the San Diego County Water Authority (senior lien revenue bonds rated 'AA+'), Orange County Water District (revenue bonds rated 'AAA'), and Los Angeles Department of Water and Power (LADWP; water bonds rated 'AA').

HIGHLY VARIABLE WATER SALES KEY DRIVER OF REVENUES

Significant developments to water supply sources and the demand profile from members have occurred in the past 10 years. Greater variability and uncertainty exists on Metropolitan's in-state water supply, the SWP. Demand level from members has declined from pre-recession levels of over 2 million acre-feet (maf) to low points of 1.63 maf in fiscal 2011 and an expected 1.6 maf in fiscal 2016. Management expects water sales to continue to exhibit a high degree of annual variability although it expects to reduce assumed levels even further in the next budget for fiscals 2017 and 2018 (assumed levels were significantly reduced in 2012 to between 1.7 and 1.75 maf annually).

Metropolitan's members are not required to buy minimum amounts of water from Metropolitan but instead use the imported water supply to supplement their other sources. However, Metropolitan's role in the region is crucial in that it supplies 40%-60% of Southern California's water supply. Fitch expects Metropolitan to remain a key water supplier although over the long term there will very likely be further pressure on demand.

Metropolitan absorbs much of the regional demand variability from naturally occurring hydrological conditions that impact the member agencies' local supplies. As drought lowers available local supplies and households have greater outdoor watering demands, members increase their purchases from Metropolitan. Conversely, as one of the highest cost resources in the region, Metropolitan bears a disproportionate impact of reduced demand, such as from the current mandated conservation levels; members reduce purchases from Metropolitan before reducing production from their own local supplies.

The biggest swing in historical annual demand has exceeded 200,000 acre-feet (af). With Metropolitan's primarily volumetric rate structure, the district budgets to achieve a strong financial cushion in order to absorb the revenue implications of a potential drop in water sales of this magnitude. A larger decline of 300,000 af is expected to occur in fiscal 2016 with estimates water sales of 1.6 maf as compared to actual sales of 1.9 maf in fiscal 2015.

STORED WATER SUPPORTS SALES DURING INITIAL YEARS OF DROUGHT

MWD made substantial investment in its physical storage facilities and inter-agency water storage agreements in the past 20 years. Storage capacity is nearly four times what it was in 1994. Metropolitan currently has 5.93 maf in storage capacity. Strong hydrological conditions allowed Metropolitan to build its stored water reserves in 2011-2013. Storage reached a high point of 3.37 maf on Jan. 1, 2013 before declining to 1.84 maf as of Jan. 1, 2015.

Metropolitan's substantial stored water position allowed it to meet the increased water demand of members during the initial years of the drought. As members are already maximizing their available local water sources, increased demand in the initial years of the drought was supplied by purchasing more water from Metropolitan. LADWP, in particular, doubled their purchases from Metropolitan in 2014 from 2012 levels, as a direct result of the drought's impact on their local supply sources. The result was strong financial performance at Metropolitan by selling water above the assumed 1.75 maf levels (actual sales were 2.0 maf and 1.9 maf in fiscals 2014 and 2015, respectively).

Financial performance in fiscal 2014 exceeded budget expectations and debt service coverage equaled 2.5x. Financial performance in fiscal 2015 continued to be strong with debt service coverage at 2.7x. Fixed-charge coverage in those years was 2.1x and 2.3x, respectively, in excess of Metropolitan's internal target for rate-setting of 1.2x.

Fitch uses fixed-charge coverage as the key financial metric for Metropolitan (a proxy for total debt service coverage) and Metropolitan uses this calculation for internal rate-setting as well. The fixed-charge calculation includes the amount of SWP costs that are a capitalized expense as if they were paid as debt service. This expense is paid to the state for SWP expenses and is a cash outflow, much as principal on debt financed assets is paid but not considered an 'operating expense' of the system.

FINANCIAL MARGINS IN 2016 WILL BE LOW

Most recent indications for water sales in fiscal 2016 are 1.6 maf, which is well below the 1.75 maf assumed in the budget. In addition, SWP costs are above budget even with the power cost savings from pumping a lower allocation from the project. Management projects debt service coverage of 1.38x and fixed charge coverage of 1.14x. While fixed charge coverage is expected to fall below Metropolitan's 1.2x target level, a mid-year rate increase is not under consideration. Management believes that the occurrence is a low-point and that coverage levels will improve in fiscal 2017. Fitch also believes that the sizable decline in financial margins was driven by the state's very quick implementation of mandatory conservation requirements on Metropolitan's purchasers and that Metropolitan will have time to address its assumed water sales in fiscal 2017 to even more conservative levels as it establishes rates to be implemented Jan. 1, 2017 in the spring of 2016. Sales are likely to remain lower in 2017 given the Governor's announcement that mandatory conservation requirements will remain in effect through October 2016.

RESERVES BOLSTERED IN 2014 and 2015; SPENT DOWN IN 2016

The healthy water sales in the initial years of the drought bolstered unrestricted reserves to approximately $1 billion and $686 million, respectively, (days cash on hand of 389 and 316, respectively) at the end of fiscals 2014 and 2015 that exceeded the minimum reserve target of approximately $200 million and maximum reserve target of approximately $480 million. In the past six months, reserves above the maximum target have largely been spent down to fund $450 million of conservation programs and to purchase property and related water rights, as an opportunity became available. Unrestricted reserves have also been spent to date for Metropolitan's budgeted $221 million for pay-as-you-go capital in fiscal 2016, although reserves will be reimbursed by the 2015 authorization series A bond proceeds.

Fitch views the rapid spend down in reserves as reasonable from a credit perspective, given the starting point of Metropolitan's reserves in excess of the maximum target level, the extreme nature of the current drought and the governor's executive order that requires each of Metropolitan's members to significantly reduce water sales. Metropolitan's historically strong reserves have provided a high degree of financial flexibility. Financial flexibility is reduced with unrestricted reserves anticipated to reach a low point at the end of fiscal 2016, projected at $440 million, but should begin to recover in fiscal 2017. Unrestricted reserves are used to provide self-liquidity for Metropolitan's $340 million in variable rate bonds, in addition to Metropolitan's revolving credit agreements.

While a sizable portion of Metropolitan's unrestricted cash reserves must be held for the litigation with SDCWA, a final judgement payment to SDCWA may not occur in the near term as the legal case continues. A judgement in SDCWA's favor was filed in 2015 but Metropolitan has appealed the decision. As required, Metropolitan currently holds $220 million of its unrestricted cash as reserves held in dispute in the litigation.