Rating Action: Moody's assigns Aa1 to CA Dept. of Water Resources' Central Valley Project Water System Revenue Bonds, Series BD and BEGlobal Credit Research - 22 Apr 2021New York, April 22, 2021 -- Moody's Investors Service has assigned Aa1 ratings to the California Department of Water Resources' Central Valley Project Water System Revenue Bonds, Series BD and BE (Federally Taxable). The bonds will be issued in the expected par amounts of $135 million and $18 million, respectively. The current issuance represents parity obligations to the Department of Water Resources' (DWR or Department) over $2.9 billion in outstanding Central Valley Project (CVP) water system revenue bonds, which are also rated Aa1 by Moody's. The outlook is stable.RATINGS RATIONALEThe Aa1 rating reflects the strong nature of the water supply contracts from which debt service payments are derived and the critical, long-term importance of DWR's wholesale water supply to its 29 contractors, which collectively provide water to 69% of the state's population. Also, key to the Aa1 rating is, the strong credit quality of the largest contractors, particularly Metropolitan Water District of Southern California (MWD; Aa1 stable revenue bond rating). While there have been no historical payment delays on the part of contractors, the additional security offered by strong step-up provisions would enable the Department to withstand a significant amount of delinquencies, lowering the potential of default even in the event of a missed payment by one of the smaller, non-rated contractors.These strong structural considerations partially mitigate uncertainties associated with the department's volatile water availability reflected in California's unpredictable precipitation levels, especially as the state enters its second consecutive dry year. The combined size and reliability of DWR's contractors also serve to offset risks associated with DWR's sizeable capital investment needs. The most notable of these are close to $1.2 billion in Oroville Dam Spillway repairs, of which $475 million is expected to be financed with bonds, with the remainder expected to come from Federal Emergency Management Agency (FEMA) reimbursements. DWR will also potentially share in the costs for California's proposed project to improve Delta conveyance facilities, with total project costs estimated at up to $10 billion or more.Notwithstanding the strength of the water supply contracts, the associated costs and required capital investments of delivering affordable state water supplies will remain an important factor in our analysis. Costs associated with California's strict legal and regulatory operating environment are also incorporated in the rating.Neither DWR's operations nor contractor payments have been impacted by the coronavirus pandemic.RATING OUTLOOKThe stable outlook on the Department's long-term water enterprise ratings reflects the time-tested strength of the underlying water supply contracts and the share of contract payments supported by the highly-rated MWD. Water deliveries have fallen below requested amounts over the past decade due to limited water supply availability, and DWR expects to reduce deliveries to 5% of requested amounts in 2021 due to current dry conditions, down from 20% in 2020. Nevertheless, given the bonds' strong security provisions, Moody's believes that material, future contract payment delinquencies or defaults are unlikely.FACTORS THAT COULD LEAD TO AN UPGRADE OF THE RATINGS- Substantially increased, long-term water availability- Successfully incorporating capital reinvestment needs while maintaining affordability to contractorsFACTORS THAT COULD LEAD TO A DOWNGRADE OF THE RATINGS- Failure to reach agreement on contract extension with remaining contractors- Significant, permanent reductions in water availabilityLEGAL SECURITYPayment of principal and interest on the bonds is secured by a pledge of gross revenues derived from payment obligations under water supply contracts with 29 participating contractors. The majority of annual debt service on outstanding obligations is additionally secured by step-up provisions through charges by the department of up to 25% of debt service on the part of participants. These step-up provisions are enhanced by the presence of larger contractors of Aa credit quality. Contractors are billed in advance for debt service. Revenue bonds are also secured by a debt service reserve fund equal to one-half of maximum annual debt service (MADS).USE OF PROCEEDSThe Series BD revenue bonds will refund approximately $178 million of DWR's $621 million in outstanding commercial paper. The bonds' final maturity in 2035 coincides with the expiration date of DWR's contractor agreements. The Series BE revenue bonds will refund $1.3 million in outstanding commercial paper, revenue bonds, and fund $10.6 million in capitalized interest.DWR's outstanding commercial paper largely financed its portion of costs, estimated at $475 million, to repair Oroville Dam's damaged main and emergency spillways. DWR expects an estimated $711 million financed with DWR commercial paper to be reimbursed by FEMA, and a portion of DWR's commercial paper is being left outstanding as it awaits these reimbursements. The BE bonds will be sold as taxable bonds since a portion of the interest on the commercial paper issued to fund Oroville Dam repairs has been outstanding longer than is typical and can't be refinanced on a tax-exempt basis. The bonds will also advance refund certain bonds for debt service savings and fund a debt service reserve.PROFILEThe California Department of Water Resources is a department within the Natural Resources Agency of the State of California and is responsible for the construction and operation of the State Water Project. The Director, the Chief Deputy Director, the Deputy Director for the State Water Project, and the Chief Counsel are each appointed by the Governor. The State Water Project consists of a massive statewide system of aqueducts, dams, reservoirs, pumping stations and electric generation facilities running from Oroville Dam, north of Sacramento to a terminus in Riverside County and delivering water supplies to 69% of the state's population.METHODOLOGYThe principal methodology used in these ratings was US Municipal Utility Revenue Debt published in October 2017 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBM_1095545. 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