LOS ANGELES — California's drought declaration will weaken the credit quality of local water agencies throughout the state, according to a recent report from Moody's Investors Service.

Gov. Jerry Brown announced a state of emergency because of a record drought on Jan. 17, urging Californians to lower water usage by 20%.

"Such a sharp reduction in water sales would be credit negative for local water agencies, since they will suffer declining revenues without offsetting rate increases," analysts said in a report released Jan. 23. "Quick implementation of such rate increases is unlikely, given the time needed to build political consensus for them and the uncertain timing of a drought recovery."

If the drought continues and water agencies do not raise rates to compensate for the lost revenues, their reserve balances could quickly be depleted, Moody's said. The diminished reserves and revenue impacts will weaken their ability to make payments on water-backed debt.

Analyst said the willingness of local water agencies to implement rate increases will continue to be a key determinate of their credit profile and the governor's emergency declaration will only amplify that.

Even before the drought announcement, some agencies had already been heading toward cost increases due to expensive water costs. The Department of Water Resources announced in November that the State Water Project allocation would be only 5% of requested deliveries, limiting agencies' access to relatively affordable state water supplies this year.

"Combine that with the possibility systems will need to seek expensive, alternative options and the drought could bring a dual threat to a water enterprise's credit quality," Moody's said.

Agencies with low debt service coverage — mainly due to the combined effects of the economic downturn and the 2007-09 drought — will experience the greatest negative effects from the drought, analysts said.

These include the city of Sierra Madre Water Enterprise, rated Ba1, which had a total annual debt service coverage of 0.27 in 2012; the Central Basin Municipal Water District, rated Aa3, which had a 0.65 coverage in 2012; and Antelope Valley-East Kern Water Agency, rated A2, which had a 0.95 coverage in 2013.

Other agencies rated by Moody's with low coverage include the Central Coast Water Authority, Kern County Water Agency Improvement District 4, and Redwood City Public Financing Authority Water Enterprise.

Some agencies are reasonably well-prepared to weather the drought, because of built-in cost inflators in rate structures, and others have responsive management that will quickly adjust rates. These systems will experience minimal credit erosion with the drought, Moody's said.

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