June 22 (Bloomberg) -- The California State Teachers’ Retirement System, the second-largest U.S. public pension, would have its credit rating lowered if Standard & Poor’s cuts California because of the state’s’ budget gap, the rating company said.

S&P said its rating criteria limits a pension fund rating to be no more than three levels higher than the general obligation creditworthiness of the governmental sponsor of the pension fund. As a result, if California’s A rating were lowered, the teachers’ pension fund’s AA rating would also fall, S&P said in a statement.

California’s full faith and credit pledge is rated A2 by Moody’s, five steps above high-yield, high-risk status, or junk. The state is also rated A by Fitch.

S&P, along with Fitch Ratings and Moody’s Investors Service, warned California in the last three weeks that its credit rating, already the lowest among U.S. states, faces further reduction as government leaders seek ways to eliminate a $24 billion budget deficit.

Republican Governor Arnold Schwarzenegger last week said he would veto any budget plan sent to him that raises taxes to fill the gap. Democrats have proposed a plan that would raise $2 billion of taxes from cigarette consumers and oil companies to help the state deal with declining revenue. The veto threat signaled an escalating battle over the deficit just a month and a half before the most-populous U.S. state is forecast to run out of cash to pay bills.

To contact the reporter on this story: Michael B. Marois in Sacramento at mmarois@bloomberg.net.

Last Updated: June 22, 2009 17:31 EDT