California Upgraded by Moody’s to Highest in 13 Years

California’s credit rating was raised to the highest since 2001 by Moody’s Investors Service, which cited improving finances in an election-year boost for Governor Jerry Brown.

Moody’s upgrade to Aa3 from A1 puts California two steps higher than Standard & Poor’s and Fitch Ratings, which last year upgraded California to A, sixth-highest. Moody’s ranks the largest U.S. state equal with Connecticut and ahead of Illinois and New Jersey. A higher rating may lower the state’s borrowing costs.

The improvement reflects California’s “rapidly improving financial position, high but declining debt metrics, adjusted net pension liability ratios” and employment growth, Moody’s analysts led by Emily Raimes said today in a report.

Brown, a 76-year-old Democrat running for a fourth term, signed a record $156.3 billion spending plan last week. A surge in revenue, mostly from capital gains and temporary income- and sales-tax increases, has taken the state from a $25 billion deficit three years ago to a record surplus.

Legislators unanimously passed a bill last month that asks voters to create a reserve fund to cushion against weaker economic growth. California would set aside 1.5 percent of general-fund revenue each year as well as capital-gains taxes that exceed 8 percent of the general fund.

Paying Debt

The budget also seeks to pay down half of the remaining $24 billion of loans and deferrals of health care, payroll and school costs used to cover deficits in the past decade, and adds funding for the California State Teachers’ Retirement System.

“California in the last three years has made great strides in managing its financial affairs,” California Treasurer Bill Lockyer said in a statement. “Moody’s action recognizes that progress and the strong, sustained fiscal discipline shown by the governor and Legislature.”

The Moody’s upgrade affected $86 billion of debt, or more than 2 percent of the $3.7 trillion municipal market.

In addition to lifting general-obligation debt, Moody’s raised state lease appropriation debt, to A1 from A2; California Judgment Trust Certificates of Participation and other issues, to A2 from A3, and revenue bonds including the South Central Los Angeles Regional Center Project to A3 from Baa1.

“The Aa3 rating also reflects the state’s volatile tax revenue structure and governance restrictions, in addition to certain recent governance changes and proposals that are meant to address those longstanding issues,” Moody’s said.

Reserve Criticized

Credit-rating companies have criticized California for its failure to set aside money when the economy is booming and for relying too much on volatile capital gains.

Investors demanded 0.36 percentage point of extra yield yesterday to buy 10-year California obligations instead of top-rated municipal bonds, according to data compiled by Bloomberg. That’s almost half the level of a year earlier and down from a peak of about 1.7 percentage points in 2009, when the state resorted to IOUs to pay bills.

A Build America Bond maturing in November 2040 traded today after the upgrade at an average yield of 4.44 percent, the lowest in 13 months. The spread was close to the narrowest in at least 16 months.

Michael Johnson, managing partner of Gurtin Fixed Income Management LLC, said the upgrade doesn’t affect his view of California’s credit. His Solana Beach, California-based firm manages $9 billion.

“We believed that the ratings agencies have had the ratings wrong for some time now,” Johnson said by e-mail. “The state’s credit quality has improved much quicker than the ratings have. We believe that much of the state’s improved credit quality is baked into its yields, but we would not expect to see some moderate additional spread tightening.”

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