California Governor Jerry Brown’s financial plan for the most populous U.S. state got a vote of confidence in the municipal bond market as Standard & Poor’s boosted its credit outlook to stable from negative.
While S&P maintained its A- rating, the lowest for any state, on California’s $71.7 billion of general-obligation debt outstanding, the revision means a downgrade is less likely. The rating company said passage of the budget mitigated the potential for a cash shortage that weighed on its outlook.
The revision reflects a budget that’s “light on smoke and mirrors and with real spending cuts and revenue increases that are credible,” said Josh Gonze, who helps oversee about $6.5 billion in municipal-bond assets as co-portfolio manager of six funds for Santa Fe, New Mexico-based Thornburg Investment Management Inc.
Brown brokered an $85.9 billion general-fund spending plan with fellow Democrats that filled what remained of a $26 billion deficit with $12 billion in spending cuts and a forecast of an equal amount in higher tax revenue from a recovering economy. The plan includes $2.5 billion in automatic additional cuts if receipts fall short of projections.
The revenue forecast put California’s budget in “dubious balance,” Bank of America Merrill Lynch analysts including John Hallacy said today in a note. The estimate for receipts of $5.2 billion more than forecast six weeks earlier “is sorely lacking in transparency and credibility,” they said.
“We believe there is sufficient uncertainty in the economic recovery, compounded by possible further weakening in California’s housing markets, to question the state’s revenue assumptions,” the analysts said in the market commentary.
The potential for economic shocks from outside the state, such as a failure to raise the ceiling on federal borrowing or to limit Europe’s sovereign-debt crisis “could alter the trajectory of the California economic recovery,” they said.
The state’s Finance Department didn’t break down its latest revenue forecast by tax category, said H.D. Palmer, a spokesman.
The new forecast was based largely on higher-than-forecast personal-income tax collections, Palmer said by telephone.
“We don’t put our thumb on the scales one way or the other,” he said.
Passage of the budget for the year that began July 1 cleared the way for California to sell short-term securities, and a projected $5 billion may be offered next month. The revenue-anticipation notes, or RANs, are typically sold when cash is low and repaid later in the fiscal year, when the bulk of taxes are collected. Without the sale, the state would run out of money, as it did in 2009, when the controller issued $2.6 billion of IOUs.
Treasurer Bill Lockyer has said he can borrow against the spending plan because automatic spending cuts, triggered if receipts fall below projections, will ensure there’s enough money left at year-end to pay off the debt.
“It’s nice to be out of the woodshed,” Tom Dresslar, a spokesman for Lockyer, said yesterday in an interview. “It confirms our view that this budget represents a significant step toward getting California’s fiscal house back in order. In addition, it bodes well for our RAN deal.”
California’s RANs will go to market as yields on such debt have plunged along with Treasuries. One-year, tax-exempt note yields fell to 0.34 percent last week, according to a Bond Buyer index, down from 0.64 percent a year earlier and 3.71 percent in 2007, before the recession. One- to three-year Treasury yields also fell in the past year, to a record 0.60 percent July 5 from about 1 percent.
“The appetite is very good for that sale,” said Kelly Wine, executive vice president of Encino, California-based RH Investment Corp. “They will probably get lower yields and low borrowing costs with that.”
S&P downgraded California’s credit in January 2010 as the state faced what was then a $20 billion deficit. California’s credit is rated A1 by Moody’s Investors Service, its fifth-highest grade, and A-by Fitch Ratings, seventh highest.
Ten-year general obligation bonds from California issuers yield 4.08 percent on average, or about 1.25 percentage points more than average top-rated debt of that maturity, according to Bloomberg Fair Value indexes. The yield difference is the smallest in about five weeks.
“The negative outlook had been linked to the possibility of a recurring cash deficiency that we now believe the enactment of the fiscal 2012 budget is likely to mitigate,” a San Francisco-based S&P analyst, Gabriel Petek, said in a statement. “The state has improved the structural alignment between its recurring revenues and expenditures.”