Fitch Rates Roseville Natural Gas Fin Auth (California) $200MM 2007A Revs 'AA-'.

SAN FRANCISCO -- Fitch assigns a rating of 'AA-' to the Roseville Natural Gas Financing Authority (the Authority) $200 million gas revenue bonds, series 2007A. The Rating Outlook is Stable.

Proceeds from the transaction will be used by the Authority (on behalf of the City of Roseville) to acquire a fixed, 20-year supply of natural gas to be delivered by Merrill Lynch Commodities, Inc., pay costs of issuance and the customer insurance policy premium, and fund capitalized interest. The bonds are scheduled to price on Jan. 23, 2007. Merrill Lynch is the senior underwriter on the bonds.

Given the structured nature of the transaction, the bond rating is determined by the credit quality of:

--The seller guarantee provided by Merrill Lynch & Co., Inc. (rated 'AA-', with a Stable Outlook by Fitch),

--The forward purchase agreement, which will be bid around the time of pricing, and is required by the trust indenture (to be rated at least 'AA-'/'Aa3' by the three rating agencies), and

-- The swap counterparty - JP Morgan Chase Bank, N.A. (rated 'A+/F1+', with a Positive Outlook).

The performance obligation of the City of Roseville is not a material factor in the rating given the support provided by a customer insurance policy provided by FSA (rated 'AAA', with a Stable Outlook) that secures the city's payments due under the supply agreement for up to two months of delivered gas until such time as the gas can be remarketed by Merrill Lynch.

Debt service on the bonds will be supported by three potential revenue streams:

--Revenues from monthly gas sales to the City of Roseville according to terms of supply agreement;

--Monthly netting payments from the swap counterparty (as explained below); and

--Payments to the trustee provided by the forward purchase agreement.

What's Unique about this Prepay Transaction:

There are unique features to this transaction as compared to some other natural gas prepay transactions rated recently by Fitch, which are summarized below.

--Bondholders take direct performance risk of both the swap counterparty and the forward purchase agreement provider.

--All but two of the triggering events that terminate the prepaid gas agreement are optional as opposed to mandatory (such as Merrill Lynch's failure to supply gas or make a payment), introducing greater reliance on the Authority to act in the best interests of bondholders.

--A funding agreement, in conjunction with the prepaid gas agreement, is used to require full payment by Merrill Lynch in a mandatory redemption of the bonds.

--One participant purchases 100% of delivered gas to the Authority (instead of multiple participants), which provides a closer alignment of the Authority and participant interests.

Credit Impact of Merrill Lynch:

At bond closing, the Authority and Merrill Lynch Commodities [is there a different short name for M-L Commods, versus M-L? so we are clear which is being referred to??]]will enter into a prepaid gas agreement that unconditionally obligates Merrill Lynch Commodities to provide a defined, 20-year supply of natural gas to the Authority, beginning in January 2008, in exchange for a prepayment amount received at bond closing. The two entities will also enter into a funding agreement that further clarifies Merrill Lynch's obligation to make a termination payment sufficient to redeem bondholders if the prepaid gas agreement is terminated. A seller guarantee is provided by Merrill Lynch & Co, Inc., the parent company of Merrill Lynch Commodities, Inc., to secure Merrill Lynch Commodities, Inc.'s performance under the prepaid gas agreement, including its obligation to make a termination payment sufficient to pay principal and accrued interest on the bonds in the event of early termination of the prepaid gas agreement.

The rating on the bonds reflects the obligation of Merrill Lynch to deliver gas (or provide sufficient financial compensation, as required by the prepaid gas agreement, if gas is not available, including a force majeure event) so that payments from the city are sufficient (along with commodity swap netting payments and income from the forward purchase agreement) to pay debt service on the bonds. Merrill Lynch is not obligated to pay debt service on the bonds.

A default of Merrill Lynch under the prepaid gas agreement, including failure to deliver gas that is not related to force majeure, payment default or a bankruptcy of either the seller or its guarantor, provides the Authority with the option to terminate the prepaid gas agreement. A termination requires Merrill Lynch to make a termination payment to the trustee sufficient to pay outstanding principal, unamortized premium, and accrued interest on the bonds until the redemption date. The bondholder is dependent on the credit risk of Merrill Lynch to meet its obligation to make the required termination payment in any termination scenario.

Credit Impact of Swap Counterparty:

The rating also depends on the use of a commodity swap to hedge natural gas price fluctuations. At bond closing, the Authority will enter into a commodity swap with JPMorgan Chase Bank, N.A. The Authority will pay the swap counterparty a monthly index-based gas price in exchange for a fixed natural gas price. The total volume of natural gas hedged by the commodity swap will equal the total volume of gas delivered according to the prepaid gas agreement.

The commodity swap is essential to the structure and the rating in that the commodity swap hedges any difference between index-based revenues the Authority will receive from monthly natural gas sales to the city and the fixed debt service the Authority must pay on the bonds. Bondholders take the risk of a payment default by the swap counterparty. In the event of a swap counterparty payment default, the Authority may not receive sufficient revenues to pay debt service. A default by the swap counterparty requires the Authority to either replace the swap within 30 days or terminate the transaction. If the transaction is terminated, the termination payment from Merrill Lynch is not required to cover the amount of the swap counterparty default.

Fitch's rating incorporates both the long-term and short-term credit quality of the swap counterparty ('A+/F1+'). Given that the swap counterparty's performance obligation is monthly, Fitch believes that the swap counterparty's short-term credit quality is sufficient to support the prepay structure at an 'AA-' rating level. JPMorgan Chase Bank is required to post collateral equal to three months of its fixed payment obligations to the Authority when any of the three rating agencies rate JPMorgan Chase Bank below the 'AA' category. JPMorgan Chase Bank will post collateral at bond closing based on its current ratings. If any of the three rating agencies ratings on JPMorgan Chase Bank fall below the 'A+/A1' level, the swap counterparty must be replaced within 30 days.

Credit Impact of Forward Purchase Agreement Provider:

Prior to bond closing the Authority will enter into a forward purchase agreement with an entity rated at least 'AA-'/'Aa3' by all three rating agencies. The forward purchase agreement will provide a guaranteed investment return for funds in the debt service fund. In exchange for cash deposits, the forward purchase agreement provider will deliver eligible securities to the trustee. The Authority's monthly deposits into the debt service fund are net funded and rely on anticipated interest earnings from the forward purchase agreement. As a result, payment of debt service is dependent on performance by the forward purchase agreement provider.

Credit Impact of City of Roseville:

The Authority has a supply agreement with the City of Roseville that requires Roseville to pay the contract price (index price minus a predetermined discount) for any gas delivered to the Authority by Merrill Lynch. The supply agreement is 'take-and-pay' requiring the city to pay for any gas delivered as an operating expense of its electric system.

A customer insurance policy from FSA provides limited payment protection for delivered gas in the event of a default by the city. The insurance policy covers up to $29,760,000 of the city's contract payments, which is equal to two months of contract payments at a price of $40 per MMBtu. Two months of coverage is sufficient to pay for delivered gas to the city until the supply agreement is terminated and the gas is available to be remarketed. Merrill Lynch is responsible for the remarketing risk and must pay the Authority the contract price for the gas, assuring timely payment of principal and interest. In the event the city defaults in a gas price environment higher than $40 per MMBtu, debt service payments are not at risk since payments in the flow of funds to the debt service fund are senior to payments to the swap counterparty.

Early Termination Risk:

Bonds are subject to mandatory redemption prior to maturity for a variety of reasons. Bondholders are required to be paid principal and accrued interest to the redemption date in the event of such a mandatory redemption. Triggering events that could prompt a mandatory termination include primarily optional events.

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