2008-07-17 23:58:08 -

- Fitch assigns a rating of 'AA' to the Eastern Municipal Water District, California (the district) water and sewer revenue certificates of participation, series 2008H (COPs). Fitch also affirms the 'AA' long-term rating on the district's $481.7 million of outstanding parity COPs. The Series 2008H COPs are scheduled to sell via negotiation on or about Aug. 14, 2008. The Rating Outlook is Stable.

The 'AA' rating is based on the district's favorable financial performance, rate flexibility, and good economic underpinnings. The rating also reflects the rising capital costs to address growth needs and the elevated level of nonrecurring connection revenues. While housing starts and resulting connection fees have cooled dramatically over the last year, the district has incorporated these

reductions into its forecasting, and financial capacity is expected to remain strong.

District water supplies come primarily from the Metropolitan Water District of Southern California (revenue bonds rated 'AA+' by Fitch), although about 20% is derived from local sources. The district provides water and wastewater service to roughly one-third of Riverside County's two million residents through various retail and wholesale connections. The county is reportedly the fastest growing in the state, experiencing population increases through 2007 of 34% since the 2000 census.

This growth has translated into receipt by the district of increasingly higher connection fee collections over the past decade as housing permits have been issued, with connection fees peaking at $99 million (equal to an extremely high 80% of district operating revenues) in fiscal 2006. However, commensurate with the slowdown occurring across the country, the issuance of housing permits within the area has experienced a rapid deceleration, translating into a 47% decline in connection revenues for the district in fiscal 2007 and a further expected drop in fiscal 2008.

Despite the falling level of connection fee receipts, which remained a relatively high 36% of operating revenues in fiscal 2007, the district still posted very favorable ADS coverage for the period at 3.8x. More importantly, ADS coverage excluding connection charges was a solid 2.1x, indicating the strength of the district's less volatile revenue sources. The district prepares five-year financial projections and has incorporated the slowing housing environment into its assumptions, estimating connection fees in the range of 20% of operating revenues. Based on this level of receipts, ADS coverage is forecast to remain between 2.0x and 3.3x through fiscal 2013; ADS coverage excluding connection fees essentially is projected to be in line with historical results.

Liquidity historically has been a credit strength, with the district maintaining several reserves with stated target levels. For fiscal 2007, liquidity overall continued to be sound. However, cash reserves were reduced somewhat during the year to further construction efforts, dropping to 308 days of expenditures from 450 in fiscal 2006. Working capital experienced a greater decline in fiscal 2007 to 111 days of expenditures from 274 days in the prior fiscal year as a result of rising accounts receivable and refundable deposits to developers in advance of construction. Alleviating any potential credit concerns though, liquidity should return to levels consistent with comparably rated credits shortly given over $70 million of bond proceeds from the current offering and the district's series 2008F and 2008G offerings, which are expected to close in July 2008, will be used to reimburse the district for prior construction expenditures.

The district's CIP totals a sizable $851 million for fiscal years 2009?2013, although anticipated funding from debt is a manageable 41%. Currently, system leverage at 38% of net assets and customer debt burden at $1,248 are moderate and in line with medians for the 'AA' rating category. Given the projected amount of additional debt to be issued through fiscal 2013, this is expected to remain the case through the near term. The five-year CIP has been escalating in recent years, although these increases appear to have leveled off as the district has incorporated all near-term projects from its long-range water and sewer master plans into the CIP; both master plans are being updated and are expected to be finalized this year with only long-term capital projects to be incorporated.

The county is part of the Riverside-San Bernardino MSA, which has experienced broad-based economic expansion in recent years while also posting impressive job gains. Annual unemployment levels in the MSA have generally improved over the past decade as urbanization has accelerated, although 2007 rates have shown some softening as economic conditions across the country have cooled. For May 2008, the MSA unemployment rate continued to weaken following declines in the construction and finance sector, rising to 7.4%, above the 6.5% and 5.2% for the state and nation, respectively.

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