California Debt Rating Raised by S&P After Surplus Forecast

California’s credit rating on its general-obligation bonds was raised by Standard & Poor’s for the first time since 2006 as tax increases championed by Governor Jerry Brown bolstered the state’s fiscal outlook.

The move by S&P affects $73 billion of debt and lifts the state’s credit grade one step to A, the sixth-highest level, according to the company. California’s outlook was moved to stable from positive, and the grade on $9.3 billion of lease-revenue bonds increased to A- from BBB+.

Brown, a 74-year-old Democrat, this month proposed a budget for the fiscal year that begins July 1 that he expects will leave the most-populous state with an $851 million surplus, the first in almost a decade. He persuaded voters in November to approve higher taxes on income and sales. The upgrade leaves Illinois, with the nation’s worst-funded pension system, as the lowest-rated state.

“S&P’s actions recognize the strides California has made toward improving its fiscal management, producing a sounder budget and getting itself on a more sustainable financial path,” Tom Dresslar, a spokesman for California Treasurer Bill Lockyer, said in an interview.

Financial Fix

The rating company cited Brown’s plan to pay down $33.5 billion of budgetary debt that accumulated in the last decade and a heightened emphasis on fixing the state’s financial health. An improving economy, coupled with spending cuts over the last two years, bolstered the fiscal footing, S&P said.

California’s jobless rate was 9.8 percent in December, down from a peak of 12.4 percent in 2010, though still above the 7.8 percent national average. Meanwhile, the state is on track to collect $5 billion more in tax revenue this month than estimated in Brown’s budget, according to the nonpartisan Legislative Analyst’s Office.

The higher rating marks a turnaround for California, which bridged more than $200 billion of projected budget shortfalls in the last decade.

S&P dropped California to A+ in February 2009, a year when the state had to issue $2.6 billion of IOUs to pay its bills amid a legislative impasse over how to erase a projected $42 billion shortfall. The following year, the company cut the state to A-.

Buyers Move

Investors bid up the state’s debt following S&P’s action.

The extra yield on some tax-free California general-obligations shrank as much as 0.07 percentage point after the upgrade, said Jason Hannon, a trader at New-York based Arbor Research & Trading. On taxable Build America Bonds from California, it fell as much as 0.1 percentage point, he said.

California tax-exempt bonds due in September 2042 traded today with an average yield of 3.3 percent, or about 0.4 percentage point above benchmark municipal debt, data compiled by Bloomberg show. That spread has shrunk in half from when the bonds priced in September.

S&P “needed to differentiate in some way between California and Illinois -- they have two completely different credit stories going on there,” said Robert Miller, a senior portfolio manager in Menomonee Falls, Wisconsin, at Wells Capital Management. The company oversees $1.4 billion in its two California funds.

“California has made some difficult decisions, and is seeing generally improving finances, while Illinois has delayed the decisions,” he said.

Illinois was cut to A- last week by S&P after lawmakers failed this month to bolster the state’s pension system.

Voters Decide

Lockyer is preparing to sell state-backed bonds over the next few months. He hasn’t said how much of the general-obligation and public-works bonds he plans to offer. The state had about $102 billion of gross tax-supported debt, the most in the nation, according to Moody’s Investor Service’s 2012 State Debt Medians Report.

Voters in November 2010 agreed to lower the threshold to pass a budget in the state legislature to a simple majority, helping Brown and Democrats avoid the prolonged standoffs that plagued his Republican predecessor, Arnold Schwarzenegger.

For at least the past two months, trading in California debt has “been reflective of a much better environment,” said Craig Brothers, who helps oversee $3 billion of munis as managing director of Bel Air Investment Advisors LLC in Los Angeles.

“Living in California, you can see that things have improved, that they’ve made some strides in improving their budget,” he said.

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