State's Bonds are Downgraded Again

California debt gets a worst-in-the-U.S. rating from Moody's

 
August 5, 2003
By Dale Kasler -- Bee Staff Writer

Unconvinced that California has solved its budget problem, a second Wall Street firm lowered the state's bond rating Monday.

This time the downgrade came from Moody's Investors Service, which chimed in the first day of business after Gov. Gray Davis signed the new state budget into law. Moody's action, coming two weeks after its rival Standard & Poor's issued a downgrade, reinforced California's plummeting standing on Wall Street as it prepares crucial bond sales to stay afloat financially.

Moody's said it was disappointed that the new budget leaves an $8 billion deficit into the next fiscal year, a gap that could top $10 billion if the state's economic forecasts don't prove true. Although it didn't mention the recall election, Moody's cited California's political gridlock and said "the state will have substantial difficulty closing this gap in the next budget cycle."

Moody's lowered California's bond rating a notch to a worst-in-the-nation "A3," or four notches above junk bond status. It had been "A2," tied with New York and Louisiana.

The downgrade will increase California's borrowing costs but it's not clear by how much. That's because Moody's was far gentler on California than was S&P, the other big Wall Street rating agency.

S&P, acting before the budget stalemate was broken, lowered California a resounding three notches July 24 to "BBB," or just two notches above junk status. S&P uses a different lettering system than Moody's.

The Moody's downgrade would generally translate into about $405 million in higher interest expense; the harsher S&P downgrade would cost about $1 billion. The actual cost might be somewhere in between, said Mitchel Benson, spokesman for state Treasurer Phil Angelides.

The higher interest would be paid over the 30-year life of $20 billion in state bonds authorized but not yet issued.

Steve Peace, the governor's finance director, said he was pleased Moody's didn't follow S&P's lead. He added that he hoped Fitch Ratings, the third big Wall Street credit-rating firm, wouldn't take the harsher stand that S&P did.

But Peace added that the recent bond market drop makes the state's lower credit rating even more problematic. Investors have been selling bonds lately, raising interest rates in general.

In an ominous turn for California, Moody's said it may not be done downgrading the state. The firm is keeping the state on its "watch list," with the potential for another downgrade, because it's worried that the new budget relies so heavily on various bond sales that could get delayed or canceled by lawsuits over constitutionality.

"The bonding plan ... exposes the state to potentially significant execution risks," Moody's said.

Moody's acknowledged that the Legislature did trim the actual deficit somewhat but said it didn't go far enough.

"In light of the constitutional requirement for a two-thirds majority vote, and the legislature's inability to agree for the past two years on whether to enact deep spending cuts or significant tax increases, the state's finances could remain pressured for several more years," Moody's said.

Marilyn Cohen, president of a Los Angeles municipal bond firm, said, "I don't feel this is the last we've heard from the ratings agencies."

Cohen, president of Envision Capital Management Inc., called Moody's downgrade "a vote of no confidence" and a repudiation of the new budget.

"This is nothing more than a Band-Aid on a situation that needs a tourniquet, and that's what Moody's is saying," she said.

The Moody's downgrade hits California just as it's preparing a $3 billion bond offering in September that's needed to patch over a seasonal cash shortage. Although that bond could carry a higher rating than the state's general rating -- because of a wrinkle in how bond markets work -- state officials are worried that California is wearing out its welcome on Wall Street.

Cohen said she believes the September bond sale "will be a good litmus test." She believes the bonds will sell but at a higher interest yield than state officials want.

She, for one, said she's steering clients away from California, at least until yields rise high enough to justify the risk.

http://www.sacbee.com/content/politics/ca/budget/story/7166303p-8113482c.html