Water utilities in California will likely see a decline in sales volume, though increasing rates can offset help offset the loss.

SAN FRANCISCO - California's serious drought will not seriously impact the credit quality of the state's water and sewer utilities in the near future, Moody's Investors Service said in a report released Sept. 17.

One of the most severe droughts on record in California has resulted in increased water conservation efforts, and water and sewer utilities have anticipated a decline in sales volume by increasing their rates.

Moody's said these recent and planned increases will offset the sales volume decline, keeping gross revenues constant. However, increasing costs will put downward pressure on net revenues and debt service coverage.

"In the early years of the three-year drought, sales volumes and gross margins have actually increased," said Michael Wertz, an assistant vice president and analyst at Moody's. "Therefore, the utilities' projected sales volume decline will typically lead to a return to normal financial performance, not the below-average performance the unusual severity of the drought might suggest."

Based on a survey of Moody's-rated California water and sewer utilities, rates will increase in fiscal year 2015 and 2016 by an average of 5.3% and 4.1%, respectively.

There were 34 survey respondents out of Moody's 104 water, sewer, and water/sewer combined systems. The respondents collectively account for approximately $27 billion in outstanding debt.

Moody's said the increases will be sufficient to offset an expected 10% sales volume decline. Anticipated volume decline is much lower than the 20% that Gov. Jerry Brown called for in January, as statewide water conservation has been short of the governor's goal.

"This range of expectations underscores the fact that performance and outcomes for individual utilities may differ substantially from the profile of the sector as a whole," Moody's said in the report.

Some utilities have actually seen their operating performance boosted by the drought. Because a large portion of water in California is used for irrigation and landscaping, the lack of rainfall has led to greater use of utility water to make up for the lack of rain, driving up water sales and revenues.

Moody's said net revenues and debt service coverage reached three-year highs for both water and sewer systems in 2013.

"Regardless of volumes, a key credit strength for the utilities is the fact they have unlimited authority to adjust rates without outside regulatory approval," Moody's said.

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