California: Where do we stand?
or, what the investment banks are saying
from an investment bank (email me for source)

Ratings: Moody's Baa1 (Negative); S&P BBB (Stable); Fitch BBB (RatingWatch Negative)

Overview
On Thursday, December 18, Fitch cut California's GO rating from A to BBB, giving the state its second downgrade this month. (Interestingly, Fitch now rates the state's lease-backed debt BBB. When the GO rating was AA, Fitch maintained a 2 notch distinction between the GO and the leases, rating them A+.) Moody's lowered the state's GO rating to Baa1 from A3 on December 9.
The downgrades follow a series of recent fiscal maneuvers: the Governor's rescission of this year's vehicle license fee (VLF) increase and the resulting revenue loss of $2.65 billion; the ensuing lack of consensus on how to adjust the budget; and the continuing uncertainty surrounding the state's deficit financing plans, which are critical to the repayment of $14 billion in short-term debt coming due this June.
As it has since the state enacted its 2003-04 budget last July, California's credit profile hinges on two key points:
· Securing a timely deficit financing to enable repayment of short-term debt. There are currently three deficit financing plans being discussed: a $15 billion, nine-year general obligation bond; a $10.7 billion, five-year sales tax bond; and an estimated $11 billion issue of takeout revenue anticipation warrants (RAWs). We believe it remains probable that, at worst, the state will be able to issue the takeout RAWs and preserve its operating liquidity and, likely, its investment grade credit ratings. Should the state be forced to rely on the outstanding RAWs' standby purchase agreements upon maturity, the rating agencies would very likely lower the state's ratings below investment grade.
· Balancing the current-year budget through a realistic mix of tax increases and spending cuts against a
background of modestly improving economic conditions . Year-to-date economic growth and revenue
performance have been encouraging, if not spectacular. Through November, the state's cashflow schedule is $1.4 billion ahead of estimates, driven largely by $0.9 billion in surplus revenues. The governor has estimated that revenues and accounting changes will produce $1.8 billion in additional cash by the end of the year. While this number falls far short of the new $2.6 billion gap created by the reduction in the vehicle license fee, it provides incremental flexibility for the legislature looking to close the deficit with spending cuts. We expect that, in the longer term, the size of the structural deficit will prevent its remedy through spending cuts alone, and in the absence of more robust economic growth, tax increases will likely be required.
While we continue to believe that California's low ratings undervalue the state's ability to obtain market access for some form of new deficit financing, we acknowledge, hypothetically, that a failure to secure new financing would be a severe blow to the state's credit profile.

posted by prof_booty | 11:38 AM