The recent, unusual torrential rains in California that displaced thousands of residents and caused billions of dollars of physical damage and economic losses highlight the increasing severity of extreme weather events in the U.S. S&P Global Ratings evaluates the effects on issuers from major weather events on a case-by-case basis. As we contact California issuers in the coming weeks, we will focus heavily on liquidity and the availability of resources to rebuild, as well as the amount of extraordinary aid they expect from federal and state sources to help defray costs.

From our initial review, it appears that no issuers suffered damage to a degree that resulted in weakening of overall credit quality. However, many communities will still be determining the level of damage in the weeks and months to come.

Insurance Availability Plays A Long-Term Role In Credit Quality Around The State

The prevalence and magnitude of storms in recent years place pressure on property and casualty insurers' financial losses. Some insurers are increasingly managing their exposure to catastrophe risks by raising premiums, limiting coverage of certain climate hazards, or exiting highly exposed regions. In the long term, this could have an effect on where and how rebuilding from storm damage occurs. In the short term, rising insurance costs for homeowners are unlikely to pressure our ratings, as the visibility of the risk is not sufficiently material. However, over time, cost increases could lead to shifts in the social and economic composition of communities. Robust economic growth and demographic trends have bolstered ratings in California, but with sustained increases in housing costs from higher insurance premiums and property tax increases required to support adaptation and resilient infrastructure investments, as well as other risks facing the state that could cost homeowners like water scarcity and droughts, governments may face revenue difficulties. (For more on the potential effects of rising insurance rates, see "Storm Clouds Or Clear Skies Ahead: How Rising Insurance Premiums From Environmental Physical Risks Could Affect U.S. Local Government Credit Ratings," published May 10, 2022.)

Impact On The State of California (GO rating: AA-/Positive)

We believe the potential financial effect on the state will be relatively small compared to the governor's proposed executive general fund budget of $223.6 billion. As of Jan. 20, 2023, California estimates $533 million in infrastructure damages incurred by local jurisdictions and an additional $113 million incurred by the state itself, for a total of $646 million. The state anticipates individual flood insurance and federal disaster aid will help mitigate the costs of storm damage, as it has in other states, such as Florida, New Jersey, and New York, that have suffered storm damage in recent years. The federal cost share of eligible damages, excluding damage to private property, is reimbursed at least at a 75% federal cost share rate, with an 18.75% state cost share and a 6.75% share left for local jurisdictions. In the next 90-180 days, the state expects to have greater clarification on the amount of public infrastructure damage eligible for FEMA Public.

In the long run, however, California will continue to need expensive infrastructure improvements to manage both floods and drought. Its fiscal 2022 and 2023 budgets already contained $8.7 billion over multiple years to minimize the immediate economic and environmental damage from the previous years' drought and to support local water projects to prepare for future drought. As a result of projected weaker revenue in fiscal 2024, the governor has proposed in his fiscal 2024 executive budget cutting back this figure by $194 million, in particular by reducing by $135.5 million the amount of state general fund support over two years for local agencies working to reduce urban flood risk. However, the state's five-year financial plan indicates that the remaining $8.6 billion multiyear flood and drought infrastructure commitment remains manageable. In his May revision, the governor will release an updated fiscal 2024 spending proposal, which may include additional spending to mitigate flood damage.

Local Government Issuers Affected Across A Wide Geographic Area

Following the series of storms, we have identified seven rated local governments that were particularly exposed to storm damage and subsequent flooding: the City of Santa Cruz, and six counties, Merced, Monterey, Sacramento, San Luis Obispo, Santa Barbara, and Santa Cruz, resulting in a broad geographic reach. We anticipate that reserve and liquidity levels for all seven will be sufficient to commence repairs while submitting eligible expenditures to FEMA for reimbursement. For example, preliminary estimates include damage to public infrastructure of $30 million-$50 million for Monterey County and $55 million for Santa Cruz County although these figures may rise substantially as assessments are completed.

We incorporate the effects of extreme weather in the analysis of an issuer's economic and financial profiles. As the extent of the damage can be determined, S&P Global Ratings reaches out to the local governments most affected. To assess both short-term financial stability and long-term financial health, our questions focus on the near-to-medium term and include:

• Extent of the damage, including the projected impact to the property tax base, if known;
• Liquidity on hand to start funding cleanup, meet upcoming debt service requirements, and fund regular operations;
• Possibility of the need for short-term borrowing to fund recovery and restoration costs;
• Expectation for delays or reductions in major revenue sources;
• Medium-term impact to financial operations, including projected cost of cleanup and repairs, and the anticipated sources of funding, such as insurance and federal or state sources;
• The likelihood and timing of FEMA support; and
• Initial response and pace of payouts from property and casualty insurers.

Will The Event Help Alleviate The Drought Conditions Or Lead To Other Obstacles?

Unfortunately, the storms are unlikely to help alleviate persistent drought conditions in California as regulatory hurdles exist to leverage stormwater if utilities could capture the runoff. However, as discussed in "Outlook For U.S. Municipal Utilities: Stable, Though Risks Are Rising," published Jan. 12, 2023, in many cases we view stormwater capture as potentially augmenting water supply during drought and other scarcity situations. For example, the Sites Reservoir project in Glenn and Colusa counties is being developed as an off-stream water source, and certain flood control districts, such as San Bernardino Valley Municipal Water District, have proposed flood and stormwater capture as a groundwater recharge option. One issue is the ability to fund these projects through typical rates and charges, given Proposition 218 restrictions. Therefore, although drought conditions are improving, reservoirs remain depleted, and we will monitor how snowpack and spring temperatures, rather than the current rainfall event, might benefit water supply in 2023.

We rate about 325 water and wastewater utilities in California; these utilities tend to have stronger liquidity than the national medians, which is an important short-term bridge until receipt of FEMA reimbursements and other sources to help fund repairs (see "U.S. Municipal Utilities Credit Brief: Medians Held Strong In 2020 AS California Retail Water and Sewer Utilities Prepare For A Dry Future," published Nov. 17, 2021). As a result, we think the recent extreme weather is unlikely to lead to rating impacts, given the robust financial capacity. Most of the affected utilities in areas with flood exposure typically hold adequate reserves with supportive emergency management and response planning, which is critical for utilities with above-average event risk.

Public Power Utilities Are Largely Unaffected

Most of the California public power issuers we rate were not materially affected by the heavy rain, winds, and flooding. Many reported downed power lines, road closures, and some damage to homes, particularly in flood-prone areas and near rivers. Numerous small-scale power outages occurred lasting a few hours, but the longest outages were in rural residential areas with small populations. Although Sacramento Municipal Utility District was hit particularly hard by the storms and had periods when over 200,000 customers were without power (almost one-third of total accounts), it restored most service within a few hours. We believe restoration costs will be manageable, especially given potential FEMA reimbursements, and the decline in SMUD's revenue will largely be offset by less fuel and power expense, such that the net impact will likely be negligible in the context of an entire fiscal year.