Fitch Rates LA Dept of Water and Power's (California) $675MM Pwr Sys Revs 'AA-'.

SAN FRANCISCO -- Fitch Ratings assigns its 'AA-' rating to the Los Angeles Department of Water and Power's (LADWP) power system revenue bonds, series 2007A-1 and 2007A-2 (fixed rate), and 2007B-1 and 2007B-2 (auction rate). The ratings reflect the underlying ratings as the bonds are likely to be insured by one of the Fitch 'AAA' rated monoline bond insurers. The bonds are secured by a net revenue pledge of LADWP's electric utility system. In addition, Fitch affirms LADWP's outstanding electric plant and power system revenue bonds at 'AA-'. The Rating Outlook is Stable.

For each series of the 2007 bonds, the pricing schedule and lead underwriter is as follow:

--Series A-1, scheduled to price the week of Sept. 24, 2007; with JP Morgan as lead underwriter;

--Series A-2, scheduled to price the week of Oct. 1; Siebert as senior manager;

--Series B-1 (auction rate), scheduled to price the week of Oct. 15; Merrill Lynch as senior manager;

--Series B-2 (auction rate), scheduled to price the week of Oct. 15; De La Rosa as senior manager.

The 'AA-' rating reflects the fundamental credit characteristics of the electric utility, including a diverse and competitive power supply portfolio, a broad and mature service territory, competitive retail rates, and a healthy, albeit tightening, financial position. Further supporting the rating is community and political support for the utility's sizable capital plan and the rate increases that will be needed to support the capital investment. Fitch views the community support as a key credit driver as the capital plan is extremely large and anticipated borrowing over the next five years, including the series 2007 bonds, tops $4.5 billion, which will double the utility's outstanding debt burden. The sizable $5.7 billion five-year capital plan is being driven by the state of California's environmental and regulatory requirements, which apply to all the state's electric utilities, and substantial needed investment in LADWP's distribution infrastructure to preserve reliability.

Credit concerns center on the execution of the substantial capital plan, an extensive, multi-level rate review process, and long-term cost pressure resulting from changes to the power supply portfolio. Fitch expects the long-term cost pressure will be driven primarily by LADWP's renewable portfolio standard (which is similar to the state requirement for investor-owned utilities) and the greenhouse gas legislation recently adopted by the state that will likely prompt long-term changes to the power supply mix of all utilities in the state.

Fitch is concerned about the rising leverage and declining debt service coverage at the utility going forward, given the political sensitivity to raising rates and the future cost pressures noted above. Although debt service coverage is still strong for fiscal year-end 2006 at 2.7 times (x), financial projections indicate there could be further deterioration of debt service coverage (and financial flexibility) as the fixed costs associated with debt service increase over the next five years. LADWP's stated financial policies, primarily debt service coverage of 2x, maintenance of current reserve levels, and the intent to fund a sizable portion of capital needs from ongoing revenues, are considered key drivers of the rating. Further deterioration beyond the utility's own financial policies, if it were to occur, could prompt a negative rating action.

The Stable Outlook reflects Fitch's anticipation that rate increases and other necessary actions will be taken to preserve the utility's financial position.

The utility's power supply in fiscal 2006 was fueled by a diverse mix of coal (45%), natural gas (26%), nuclear (9%), renewable generation (6%), hydro-electric generation (4%), and purchased power (10%). The low-cost coal and nuclear power supplies compete favorably in the California market which is primarily dependent on natural gas pricing.

Significant investment has been made since 2000 to re-power and replace LADWP's owned natural-gas fired generation units that are located within the city. The investment of over $1 billion (much of it from ongoing revenues) between 2000 and 2006 has preserved LADWP's long power position, while reducing costs and increasing efficiency. Additional spending over the next five years, included in the current capital plan, will focus on continued investment in LADWP's approximately 4,500MW (megawatts) of owned natural-gas generation within the city, the investment of approximately $2 billion for additional renewable resources to meet LADWP's renewable portfolio standard of 20% by 2010 and 35% by 2020, and the investment of approximately $2 billion in reliability improvements. LADWP is in the process of updating its integrated resource plan, which will update future generation and transmission investment needs. Capital spending is not expected to change substantially when the final integrated resource plan is adopted in 2008.

The utility's financial position is healthy. Debt service coverage of approximately $4.2 billion in outstanding debt was 2.7x in fiscal 2006. This was down from levels that historically exceeded 3.5x. While 2.7x is still strong coverage, it provides less free cash flow for capital spending for the utility at a time when capital spending is projected to increase substantially over the next five years. Liquidity remains good with approximately $765 million in unrestricted cash (139 days operating cash) at the end of fiscal 2006, including $450 million in the Debt Reduction Fund. Financial projections indicate that debt service coverage may deteriorate down to the utility's minimum policy of 2x coverage, which provides around 1.5x coverage following the 7% transfer to the city's general fund. The anticipated decrease in coverage reflects the expectation that annual rate increases will be modest at approximately 3%, despite the significant anticipated increase in debt service and some operating cost pressure.

Although LADWP has competitive rates compared to both regional investor-owned and municipal utilities, the lengthy and multi-level rate process, which includes verification with an independent financial consultant and consultation with 89 neighborhood councils in addition to Board and City Council approval, may limit future rate flexibility. The utility does have a pass-through mechanism in its rates to recover costs including fuel and purchased power that was implemented in 2006. However, the pass-through is being phased in and the utility is probably 18 to 24 months away from reaching a point where full recovery is achieved of all the costs embedded in the cost recovery mechanism.

LADWP, the country's largest municipal utility, serves 1.4 million customers with a system peak of 6,102MW. Only 30% of energy sales are to residential customers, reflecting a strong commercial presence in the city, which accounts for 57% of revenues. The customer base is diverse and mature and load growth is projected to average 1.1%, in-line with historical growth.

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