SAN FRANCISCO — Moody's Investors Service downgraded $3.2 billion of Los Angeles bonds yesterday, as elected officials in the nation's second-biggest city battled over a plan to raise electricity rates.

The agency downgraded the city's general obligation bonds to Aa3 from Aa2 and reduced the ratings on other general fund debt by one notch. The non-GO debt carries ratings from A1 to A3, depending on the exact security structure. Moody's maintained a negative outlook on the debt.

"The downgrade primarily reflects the continued erosion of the city's historically better-than-average willingness and ability to quickly rebalance its budget mid-year," Moody's analyst Eric Hoffmann said in a report. "This is a particularly important rating factor for Los Angeles since its balance sheet has typically been relatively weak for the rating level."

Moody's cut its outlook on Los Angeles to negative in February, as policymakers fought over job cuts that would help close the city's $212 million general fund budget deficit for this year.

Since then, the city has whittled the deficit projection down to $160 million and approved 4,000 job cuts, but the City Council and Mayor Antonio Villaraigosa have been locked in a battle over electricity rates for the last few weeks, imperiling a $73 million transfer the Los Angeles Department of Water and Power had promised the general fund.

The utility says it can't afford the transfer without a rate hike. The City Council rejected the first part of a 22% rate hike championed by the mayor, saying ratepayers couldn't afford an environmental surcharge included in the increase. The council passed a smaller increase that council members said covered the department's financial needs, but not Villaraigosa's fund for environmental projects.

Mayoral appointees at LADWP refused the smaller rate hike and said the utility won't make its scheduled transfer to the general fund. The two sides had yet to reach a compromise to resolve the impasse at press time yesterday.

Controller Wendy Greuel earlier this week said Los Angeles will have to spend most of its reserves or run out of cash by May 5 without the transfer.

"The downgrade also partly reflects the likelihood that the city's general fund reserves at the end of the current fiscal year could be materially weaker than we had previously expected, now that an expected transfer from the Department of Water and Power may be reduced," Hoffmann said.

The city's inability to agree on a resolution may be even more worrying than the loss of the LADWP transfer.

"This $73 million reduction would pose a material, though not unmanageable, challenge for the city's general fund," Hoffmann said. "Given its significance to the general fund, the increased political contention around it is a negative credit development."

The Moody's analyst expects the city to cover the shortfall using its $199 million reserve fund. Interim city administrative officer Raymond Ciranna earlier this week said he expects to add more money to the reserve by the end of the fiscal year on June 30, bringing its total to $254 million before subtracting the $160 million deficit.

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