The vulnerable-listed painted honeyeater was discovered by Australian National University researcher Ross Crates last week in the Burragorang Valley which sits within the Blue Mountains National Park.
Mr Crates says the bird is rarely seen that close to Sydney or the coast and suggests they are most likely seeking drought refuge.
"If they start losing their drought refuge due to the dam proposal, it's not going to end well," he told AAP on Thursday.
The plan to raise the dam wall by about 14 metres will see the area flooded through a "controlled release" of water which Mr Crates says will mean the species will lose its habitat alongside the critically endangered regent honeyeater which was found to breed in the area.
The valley is the third known location throughout NSW, northern Victoria and southern Queensland that the painted honeyeater has been found, he added.
Although they aren't as at risk as the regent honeyeater, Mr Crates warns they could end up in the same position if they keep losing their habitat.
"Its another threatened species we have found that's going to lose its habitat if the dam wall is raised," he said.
The NSW government believes the Warragamba proposal will reduce and manage flood risk in the Hawkesbury-Nepean Valley.
Community group Give A Dam spokesman Harry Burkitt said the discovery is another example of a threatened species being pushed to the "brink of extinction" by the plan.
"The raising of Warragamba Dam wall is being imposed on the people of western Sydney with no social licence," he told AAP on Thursday.
"This dam proposal has very little to do with protecting lives and everything to do with the Liberal's opening the floodgate to their developers on western Sydney's agricultural floodplains."
Infrastructure NSW, which is overseeing the project, has been contacted for comment.
It's previously told AAP assessments have been undertaken of all "likely occurring" threatened species including the regent honeyeater and potential impacts will be included in the environmental impact statement.
The EIS is due to be published for public comment in 2019.