Fitch Affirms SMUD (CA) 'A'; Maintains Positive Outlook.

NEW YORK -- Fitch Ratings affirms Sacramento Municipal Utility District's (SMUD) long-term rating of 'A' on $1.7 billion electric revenue bonds and $479 million subordinated bonds. The Rating Outlook remains Positive (see below).

SMUD's credit is reflective of competitive electric rates and a conservative power supply strategy aimed at mitigating its exposure to potentially volatile electricity markets. As part of this strategy, SMUD is taking steps to replace high-priced purchased power contracts with more reasonably priced and owned generation facilities closer to its customer base. In addition, Fitch views SMUD's customer base as favorable due to the regional economy and diversification among customer classes.

SMUD's current power supply derives from 22% owned resources, 21% from SMUD-sponsored power projects, and 57% purchase power contracts or arrangements. In 2006, SMUD will add 100% of the off-take from the 500-megawatt (mw) natural gas-fired Cosumnes plant to its portfolio, decreasing the purchase component of its power supply to approximately 30% over the next few years. The Cosumnes plant will be owned by a separate joint power authority, the SMUD Financing Authority, creating an off-balance-sheet obligation similar to its obligation to three cogeneration facilities.

In 2004, SMUD had aggregate senior and junior lien debt service coverage of 2.4 times (x) (1.7x after adjusting for off-balance-sheet obligations associated with three cogeneration projects) and currently has approximately $275 million of unrestricted cash reserves, including $75 million in a rate stabilization fund. These balances are equal to three months of operating expense. Further supporting its liquidity profile is its $200 million commercial paper program. During 2006, SMUD expects all $200 million of commercial paper capacity to be available. In aggregate, Fitch views SMUD's liquidity as adequate, especially given its substantial hedged position of natural gas over the next two years.

SMUD's credit concerns include increasing gas commodity exposure, lower projected financial margins, and the need to replace an expiring federal hydroelectric operating license for the district's Upper American River Project (UARP) by 2007. Fitch also notes that SMUD is currently exploring the practicality and cost of expanding its service territory to nearby communities (potentially adding 73,000 customers, or 12% to its customer base).

In aggregate, SMUD's primary fuel mix is natural gas, which is expected to fuel approximately 60% of its energy supply in 2006. Partially mitigating Fitch's concern regarding cost volatility is management's strategy and success of locking in gas supply, prices and transportation through various physical and financial hedges. This component of its risk management is important given the recent volatility of natural gas prices and that SMUD's rate structure does not include an automatic fuel adjustment clause.

SMUD's reduced projected financial margins have been caused primarily by higher than expected fuel costs. Fitch recognizes SMUD's ability and willingness to raise rates to mitigate higher costs. SMUD's Board of Directors recently approved a 6% rate increase to mitigate higher than expected fuel costs. Nevertheless, SMUD's forecast over the next few years shows lower debt-service coverage and cash reserves relative to earlier forecasts. SMUD's long-term financial targets, however, remain in line with historical levels. Management has assured Fitch that it will take appropriate actions in the next one to two years to meet its stated financial targets.

Fitch's Rating Outlook was revised to Positive from Stable on May 4, 2004 as a result of improving financial strength and the implementation of the above-mentioned power supply and hedging strategy. Over the next 12-15 months Fitch will be monitoring SMUD's ability to attain prior forecasted financial targets as well as developments of the UARP license renewal and cost of the potential annexation of nearby customers to determine to status of the Positive Rating Outlook.

SMUD is a municipal retail utility providing electric service to approximately 553,000 primarily residential, commercial and governmental users, in the state capital of Sacramento.

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