Fitch Rates Baltimore, Maryland's Water Revs 'A'/Wastewater Revs 'A+'; Stable Outlook.

NEW YORK -- Fitch Ratings assigns an 'A' underlying rating to Baltimore, MD's approximately $25 million subordinate project revenue bonds (water projects), series 2006A, and an 'A+' rating to the approximately $49 million project revenue bonds (wastewater projects), series 2006C. The bonds are expected to price on or about May 11 through a syndicate led by Merrill Lynch & Co. The Rating Outlook is Stable.

Fitch also affirms the rating and Stable Outlook on the following outstanding debt:

-- $321 million parity water revenue bonds 'A+';

-- $268 million parity wastewater revenue bonds 'A+';

-- $41 million subordinate water revenue bonds 'A';

-- $102 million subordinate wastewater revenue bonds 'A'.

The 'A+' rating reflects the strength of suburban wholesale arrangements that add stability to the water and wastewater systems' revenue streams, maintenance of adequate cash balances, a demonstrated resolve to raise rates, as well as the satisfactory legal structure. Credit concerns surround significant capital needs, reflective of an aged system, and continued need to raise rates to meet coverage levels, finance an extensive capital plan, and preserve financial flexibility. Also, the city has engaged in a sizable amount of swap activity, which could lead to financial exposure.

The systems serve approximately 1.8 million people within the city of Baltimore and the outlying suburban areas of Baltimore, Anne Arundel, Carroll, Harford, and Howard counties. The city owns two water treatment plants, Ashburton and Montebello, treating water primarily from three local reservoirs and the Susquehanna River. The system filters and distributes approximately 245 million gallons per day (mgd) of drinking water. The water system capital improvement plan (CIP) through 2011, estimated to cost $561 million, is focused on the expansion of existing treatment facilities and the construction of a new plant, as well as distribution system improvements to improve currently high unaccounted-for water loss.

The city's wastewater treatment plants include Back River (180 mgd) and Patapsco (63 mgd). The estimated $907 million wastewater system CIP is significant, including costs associated with a consent decree to deal with combined sewer overflow and sanitary sewer overflow, executed in April 2002, and upgrades to conform to the enhanced nutrient reduction regulations as part of the Chesapeake Bay restoration initiative. The latter project will largely be funded by the statewide environmental surcharge. Nearly half of both systems' CIPs will be funded with bonds, using Baltimore County sources as the secondary support, as per the wholesale agreement.

Both systems have solid cash liquidity with over 90 days of unrestricted cash on hand, which includes monies in an operating reserve and rate stabilization fund (RSF). Management targets an unrestricted cash balance at a minimum of 25% of annual operating and maintenance costs for each system (an 8% reserve is required by indenture), and coverage is targeted at 1.4 times (x) on senior lien bonds. While liquidity is sound, the systems could face exposure from the $423 million in outstanding system swaps. Termination values associated with the swaps are sizable and could materially affect financial performance, but Fitch believes management will take prudent steps to minimize such exposures.

Annual debt service coverage for senior lien debt is adequate at 1.6x in the water fund and 2.3x in the wastewater fund for fiscal 2005. Total debt service coverage, including both senior and subordinate debt, equaled 1.4x for the water fund and 2.0x for the wastewater fund. Including the current issuance and all other planned issuances through fiscal 2011, the forecasting period, total coverage is projected to average 1.4x for the water fund and 1.3x for the wastewater fund. To meet coverage levels, both systems are dependent on continued retail rate increases projected at 9% annually through at least fiscal 2011.

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.