KBRA Assigns AA Rating, Stable Outlook to the Department of Water and Power of the City of Los Angeles - Water System Revenue Bonds

KBRA assigns a long-term rating of AA to the Department of Water and Power of the City of Los Angeles (LADWP, or the Department) Water System Revenue Bonds, 2026 Series A. The Outlook is Stable.

LADWP is the nation’s largest municipal utility and serves as the exclusive provider of electric and water utility services to a broad, primarily residential customer base within the City of Los Angeles (the “City”). Proceeds of the 2026 Series A Bonds will primarily be used to pay costs of capital improvements to the Water System and pay certain costs of issuance. The 2026 Series A Bonds are on parity with approximately $6.07 billion of Water System Revenue Bonds and revolving loans, $729.8 million of loans from the State Water Resources Control Board, and a $2.7 million loan from the Department of Water Resources outstanding as of July 2, 2026.

The long-term rating reflects the Department's stable operating and financial performance. Conservative, Board-adopted financial planning criteria and full rate-setting authority support consistently strong liquidity, sound debt service coverage, and elevated but manageable leverage. Counterbalancing these strengths is the need for ongoing increases in already elevated water rates and for substantial additional indebtedness over the near to medium term as the Department addresses costly Water System requirements, including compliance with EPA Safe Drinking Water mandates and the implementation of a $10.1 billion FY 2027 - FY 2031 Water System Capital Plan. The Capital Plan, which has grown by 30.5% in a year, is expected to be funded largely from proceeds of existing and future Water System Revenue Bonds, and additional loans and grants (73%), with the balance funded on a pay-go basis (27%).

Contingent liability risks related to the January 2025 wildfires and future wildfires and to the strict liability standards imposed by California’s inverse condemnation law remain a critical and evolving concern. Potential adverse litigation outcomes relating to the 2025 wildfires or to future wildfires which pressure the Department’s ability to meet the related liability exposure would likely have a negative impact on the rating.

A Master Complaint consolidating several hundred state court actions including two putative class action complaints involving claims for inverse condemnation, dangerous condition of public property and nuisance relating to both the LADWP Power System and Water System, as well as to certain vacant city owned lots, was filed on October 8, 2025, and amended in December 2025. The Master Complaint generally alleges with respect to the Water System that i) LADWP failed to maintain the Water System for firefighting purposes, including the Santa Ynez Reservoir and, in some cases, the Chautauqua Reservoir, ii) the Water System was designed for ordinary urban use rather than wildfire conditions; and iii) Water System failures (notably the Santa Ynez Reservoir being offline) materially worsened firefighting outcomes. Prior to consolidation, one of the class actions had asserted over $10 billion in damages. The consolidated class action complaint does not currently assert a figure for damages, but there can be no assurances that total claims against all defendants will not be in the tens of billions of dollars.

On February 19, 2026, in an adverse procedural development (but not a finding of liability), the Los Angeles Superior Court found that plaintiffs may pursue inverse condemnation claims against the Water System. The denial does not establish liability but leaves the Water System inverse condemnation theory alive through discovery and likely increases the probability that settlement pressure, litigation costs, liquidity needs, or future rate recovery will become more prominent credit considerations.On March 27, 2026, the City filed a writ petition in the appellate court, challenging the trial court’s refusal to dismiss the Water System inverse condemnation claim at the pleading stage. The appeal was denied on May 6, 2026. The City subsequently filed a petition for review of the trial court's decision to the California Supreme Court. The petition for review was granted on June 24, 2026.

Additional lawsuits continue to be filed, including by certain insurance carriers asserting subrogation rights and by at least one public entity, alleging inverse condemnation claims. One insurance carrier plaintiff asserts damages in excess of $3 billion. Litigation remains at pleading and consolidation stage, and the Department’s ultimate financial exposure cannot yet be estimated. The Department and the City of Los Angeles deny all liability claims.

While full litigation exposure may not be known for years, various financial mitigants are available. Inclusive of commercial insurance, the Wildfire Self-Insurance Trust Fund and additional self-insurance, the Department has $319.6 million available for wildfire losses as of May 31, 2026. The portion of the Water Revenue Fund set aside for self-insurance that is specific to the Water System totaled $30.8 million as of this date. The Department has also provided for $200 million of wildfire coverage through wildfire index catastrophe bonds ($100 million available through September 2028, and $100 million available from July 2026 to August 2029.) The Department can also rely, if necessary, on internal and external liquidity, bonding capacity, and the potential recovery of judgement or settlement costs through various rate adjustment factors.

Water System Revenue Bonds and other parity indebtedness are secured by the Water Revenue Fund. While the Master Resolution includes a sum-sufficient rate covenant, internal Board policy targets minimum debt service coverage (“DSC”) of 1.70x. FY 2025 net revenues available for debt service of $798.9 million, down 15.9% year over year due to an increase in purchased water, maintenance and other operating expenses, and a decline in capital contributions, provided DSC of 1.83x, down from 2.19x in FY 2024. Other Board-determined financial planning criteria include maintenance of at least 150 days operating cash and a debt to capitalization ratio below 65%, both of which were met in FY 2025. The Master Resolution’s additional bonds test requires adjusted net income of at least 1.25x maximum annual debt service, providing protection against overleveraging.

KBRA projects DSC to decline through FY 2031 with the implementation of the largely debt financed Capital Plan. The Capital Plan addresses certain water quality compliance mandates, distribution system expansion and upgrades, protection of existing water supplies, and development of new water resources. It also includes roughly $300 million for Pure Water Los Angeles, an initiative to maximize the recycling of wastewater from the City’s Hyperion Water Reclamation Plant. The total preliminary capital cost for Pure Water Los Angeles, a joint effort between LADWP and the Los Angeles Bureau of Sanitation, is estimated at $20 to $25 billion (in 2024 dollars), to be phased in through 2058. The Department projects Capital Plan expenditures for FY 2027 alone to total approximately $1.42 billion.

Despite the above average wealth levels of the Department’s rate base, rate flexibility has declined in recent years, and residential water rates appear elevated relative to many California public retail water utilities, particularly on a volumetric basis, though below San Francisco PUC and slightly below San Diego under comparable meter size and usage assumptions. The Department’s average Water System rates for all customer classes increased at a 5-year CAGR (2020–2025) of 10.0%, reflecting increases in various rate adjustment factors to cover the rapidly rising costs of water purchased from the Metropolitan Water District - which provides roughly 50% of the Department’s water supply - and expenditures for water quality and reliability improvements. FY 2025 average Water System rates jumped approximately 23.6% year over year, from $8.81 to $10.90 per 100 cubic feet (“HCF”) of metered usage, and while base rates remained constant for FY 2026, the Department increased the base rate target by 0.58% via the Water Rate Ordinance’s pass-through adjustment mechanisms. Further rate increases are anticipated throughout the Water System Capital Plan period, irrespective of wildfire-related expenditures not otherwise met.

FY 2025 Water System operating revenue increased 16% YoY to approximately $1.9 billion from $1.6 billion. Management attributes the increase to consumption growth and the increase in the system average rate. Total water sales increased to 190.1 million HCF from 180.5 million HCF in FY 2024, while average revenue per HCF increased across all major customer classes.

The Department has experienced persistent turnover in senior leadership for more than a decade. Most recently, Los Angeles Mayor Bass has designated David W. Hanson to serve as the Department’s Interim General Manager. The Water System, with approximately 2,400 employees, is led by a Chief Operating Officer and Senior Assistant General Manager.

The Stable Outlook reflects our continued view that cost recovery through rate adjustments, ample liquidity, and available financial mitigants should allow for the maintenance of adequate DSC and stable financial metrics as the Department addresses potential wildfire judgement or settlement costs, achieves compliance with EPA mandates, replaces aging infrastructure, and expands local water supplies through implementation of its ambitious Water System Capital Plan.

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