California Rallies as Tax Win Signals Debt Upgrade

California debt is rallying the most in three months as Governor Jerry Brown’s tax-vote victory leads investors to bet the state will get its first credit-rating upgrade since 2006.

Proposition 30, which won voter approval Nov. 6, temporarily raises some levies for top earners in the most- populous U.S. state. Passage averted $5.5 billion of cuts to public schools. The 74-year-old Democrat counted on the tax revenue to close a $16 billion deficit in the budget for the year that began July 1.

The successful referendum contrasts with the 1978 passage of tax limits known as Proposition 13. The measure capped local property taxes, led to cuts in school spending and fueled budget deficits that left California with Standard & Poor’s lowest credit rating for a U.S. state.

“Prop. 30’s passage strengthens the state’s credit quality,” California Treasurer Bill Lockyer said in an e-mail through Tom Dresslar, a spokesman. “But we have more work to do to put our budget on a solid, long-term foundation.”

The yield penalty investors demand on bonds sold by California and its localities shrank 13 percent from mid-October through the day after the vote, the biggest improvement since August, data compiled by Bloomberg show.

Budget Key

S&P, which hasn’t upgraded California since 2006, revised its outlook to positive in February. It said it would boost the grade within two years if California resolved its budget gaps.

The tax measure “paves the way for S&P to upgrade them,” said Robert Miller, a senior portfolio manager in Menomonee Falls, Wisconsin, for Wells Capital Management, which oversees $30 billion in municipal bonds. He said his company’s national funds have been overweight California for more than a year on the expectation that the state would win a credit upgrade.

With muni interest rates near generational lows, investors have bought riskier credits such as California to boost returns. Yields on AAA 10-year munis fell to 1.63 percent yesterday, close to the lowest ever for a Bloomberg Valuation index that began in January 2009.

Debt Leader

California and its localities have earned 8.9 percent this year, according to S&P data. Even with three municipalities filing for bankruptcy protection since June, the state is still poised to beat the broader market for the third straight year, the longest stretch since 2006.

S&P rates California A-, seventh-highest and a step below Illinois, which is grappling with about $8 billion of unpaid bills. California’s $103 billion of gross tax-supported debt is most among U.S. states, according to Moody’s Investors Service.

S&P said the tax plan would lead the Golden State toward paying down $34 billion of budget liabilities from previous deficits by 2016.

California’s credit was cut by S&P to the current level in January 2010, after a budget stalemate forced it to issue IOUs. Excluding so-called recalibrations, 2006 was also the last time Moody’s and Fitch Ratings increased their marks for the state.

The state’s general obligations have extended a rally since Election Day on Nov. 6.

A California bond maturing in 2021 traded Nov. 7 at an average yield of 1.61 percent, the lowest ever, data compiled by Bloomberg show. Its spread over AAA munis has dropped about 50 percent since Brown took office in 2011, Bloomberg Valuation data show.

School districts have also seen yields fall as Proposition 30’s passage averts cuts.

They are the “principal beneficiaries” of the measure, said Chris Mauro, head muni strategist at RBC Capital Markets LLC in New York, in an interview.

Los Angeles Unified School District, the biggest in California, saw yields on its debt fall after the referendum. Bonds maturing in 2028 traded Nov. 7 at an average yield of 2.15 percent, the lowest ever.

Following are pending sales:

NEW JERSEY plans to sell $2.6 billion of short-term debt with JPMorgan Securities LLC as underwriter. The state postponed the sale last week because of Hurricane Sandy. (Updated Nov. 8)

MINNESOTA is set to sell $654 million of debt backed by an annual appropriation as soon as Nov. 14. Proceeds will refund tobacco bonds sold in 2011, according to bond documents. (Updated Nov. 8)

To contact the reporters on this story: Brian Chappatta in New York at bchappatta1@bloomberg.net; Michael B. Marois in Sacramento at mmarois@bloomberg.net

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net

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