The second revision since July comes as the most-populous state prepares to sell $2 billion in general-obligation bonds. California’s A- rating, S&P’s fourth-lowest investment grade and the lowest of any state, was affirmed on $73.4 billion of general-obligation debt.
California is positioned for a higher grade if revenue comes closer to projections in Governor Jerry Brown’s budget, S&P said. Brown is promoting a November ballot measure that would raise income taxes on people who earn more than $250,000, and increase sales taxes statewide to avoid further cuts to education.
“Barring any other credit deterioration, we think the state is poised for credit improvement -- and potentially a higher rating -- pending its ability to better align its cash performance and budget assumptions,” said Gabriel Petek, an S&P analyst, in a statement. “By downsizing its spending base, the state has corrected a significant portion of its budget imbalance.”
California will offer about $2 billion of general- obligation bonds to refund debt March 1, the largest sale by the state since October. The most indebted state will also sell as much as $1 billion of cash-flow notes Feb. 22.
In January 2010, California’s credit rating was cut one level, with a negative outlook, after a budget stalemate in August forced the state to issue $2.6 billion of IOUs to pay some bills. In July 2011, S&P boosted the outlook to stable, saying passage of Brown’s budget mitigated the potential for a cash shortage. The state’s rating remains S&P’s fourth-lowest investment grade and the lowest of any state. Moody’s Investors Service gives it an A1, the second-lowest after Illinois.
“The fact that California’s ratings outlook has shifted from negative to positive in less than a year is a powerful vote of confidence in our state,” Brown said in a statement.
While the state isn’t at risk of default, S&P’s action ignores concerns about California’s liquidity, said Richard Larkin, director of credit analysis at Herbert J. Sims & Co. in Iselin, New Jersey.
Brown’s budget for the fiscal year starting July 1 assumes voters will pass tax increases in November, without which the state would cut $4.8 billion from public schools, the equivalent of taking three weeks from the academic year.
“S&P’s rating action is either vastly forward-looking or oblivious to real-time cash-flow problems,” Larkin said by e- mail.
California collected $528 million less in taxes in January than Brown estimated in his latest budget, Controller John Chiang said Feb. 10. Most of the shortfall was in income taxes, down $525 million, or 6.3 percent less than projected Chiang said. Corporate taxes were down $127.9 million, while sales taxes were up $42.8 million.
California’s fiscal situation doesn’t “warrant consideration of an upgrade until their budget is truly stabilized,” Larkin said. “I am at a loss as to what prompted today’s decision.”
The state’s brightening outlook corresponds with the rebound in the stock market, since the state depends disproportionately on capital-gains taxes, said Michael Pietronico, who manages $670 million of municipals as chief executive officer at Miller Tabak Asset Management in New York.
Possible cash-flow disruptions shouldn’t obscure the improvement in California’s budgetary picture, he said in a telephone interview.
“Investors tend to anticipate the state to have short-term cash-flow needs,” Pietronico said. “Most large states and municipalities do at some point, and it seems to have been well- budgeted and forecast so no one was surprised.”
California 10-year general-obligation bonds yielded 85 basis points more than AAA municipal debt yesterday, compared with a peak yield spread in the past year of 1.47 percentage points in June, according to data compiled by Bloomberg. A basis point is 0.01 percentage point.
State and local debt of California returned a total of 14.8 percent last year, according to a Bank of America Merrill Lynch index. That’s more than the 11.2 percent for the full $3.7 trillion municipal market, the 9.8 percent for U.S. Treasuries and the 7.5 percent for investment-grade company debt.
“Whenever ratings agencies take positive action, ultimately it should accrue to the benefits of taxpayers by constraining borrowing costs,” said Tom Dresslar, a spokesman for state Treasurer Bill Lockyer, in a telephone interview.
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