June 19 (Bloomberg) — California’s credit rating, already the lowest among U.S. states, may be cut several levels by Moody’s Investors Service as government leaders seek ways to eliminate a $24 billion budget deficit.
The move would affect $72 billion of debt, Moody’s said in a statement today. California’s full faith and credit pledge is rated A2 by Moody’s, five steps above high-yield, high-risk status, or junk.
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A downgrade may increase the state’s borrowing cost and raise the yield paid to investors on its bonds. Standard & Poor’s put California on watch for a possible reduction earlier this week, and Fitch Ratings did the same thing May 29. The rating companies cited the most-populous state’s deficit — amounting to more than 20 percent of the general fund — and lawmakers’ inability to agree on how to close the gap.
“If the Legislature does not take action quickly, the state’s cash situation will deteriorate to the point where the controller will have to delay most non-priority payments in July,” Moody’s said in a report today. “Lack of action could result in a multi-notch downgrade.”
Earlier this week, Republican Governor Arnold Schwarzenegger said he would refuse to back any tax increase as Democrats proposed a budget that would raise $2 billion from cigarette consumers and oil companies to help the state deal with declining revenue. The veto threat signaled an escalating battle over the deficit just a month and a half before the most- populous U.S. state is forecast to run out of cash to pay bills.
‘Clear Warning’
“I don’t think I’ve ever seen the phrase multi-notch in a ratings write-up,” said Schwarzenegger’s budget spokesman H.D. Palmer. “It’s another clear warning from the financial markets that there will be costly consequences if the Legislature doesn’t’ quickly send the governor a budget plan that he can sign.”
California taxable 30-year Build America Bonds paying 7.55 percent traded at about 94.56 cents on the dollar yesterday to yield 8.03 percent, down from as high as 98.16 cents and 7.71 percent a week earlier, according to Municipal Securities Rulemaking Board trade data.
A further California reduction might ripple through the U.S. economy and its financial markets, said Shaun Osborne, chief currency strategist in Toronto at TD Securities Inc., a unit of Canada’s second-biggest bank.
“California has to solve its budget issues itself but the issue reflects the weak fiscal position of the U.S. overall,” Osborne said. “California is the eighth-largest economy in the world, and so I think it would be a psychological blow for the U.S. dollar if there was a downgrade.”
Selling Notes
Without a balanced budget, California’s treasurer and controller have said the state will have difficulty securing the short-term loan needed to fund the government until the bulk of tax collections come in later during the budget year.
Under U.S. Securities and Exchange rules, money market funds are only allowed to buy tax-exempt bonds that carry AA ratings or higher. Issuers with municipal ratings below AA have been forced to buy credit enhancement, such as bond insurance, to make their bonds available to the funds.
“We have historically traded above our GO rating,” Palmer said, referring to general obligation debt. “That said, if in fact there were to be multi-notch downgrade, there would be significant costs associated with it and that underscores the necessity for the Legislature to move very quickly to get a budget down to the governor in a form that he can sign.”
Default Risk
Tom Dresslar, spokesman for California Treasurer Bill Lockyer, said Moody’s should have more prominently noted in its report the nominal chance that the state would actually default. Lockyer has led an effort to push rating companies to assign municipal bond grades that reflect their lower risk of default compared with corporate debt.
“This is Moody’s opinion and as we have seen time and time again, the opinion of Moody’s, Fitch and Standard & Poor’s is worth squat,” Dresslar said. “They say that the likelihood of bond repayment is very high. That’s an understatement. We have never failed to make a bond payment on time and in full, never in our history. They buried the lead.”
To contact the reporter on this story: Stacie Servetah in Trenton at [email protected]; Michael B. Marois in Sacramento at [email protected].
Last Updated: June 19, 2009 15:21 EDT
By Stacie Servetah and Michael B. Marois
Source: Bloomberg