California’s B-B-Blues in the Night: FITCH DOWNGRADES CALIFORNIA GENERAL OBLIGATION BONDS TO ‘BBB’; MAINTAINS WAITING WATCH NEGATIVE

• THE DOWNGRADE TO 'BBB' is based on the state's continued inability to achieve timely agreement on budgetary and cash flow solutions to its severe fiscal crisis

• THE RATING WATCH NEGATIVE reflects the short-term risk that institutional gridlock could persist, further aggravating the state's already severe economic, revenue and liquidity challenges and weighing on the state's credit.

• “The riskier a bond is, other things being equal, the lower its rating. The highest-rated nondefaulted bonds are rated AAA or Aaa, and the lowest are rated C, with defaulted bonds rated D; thus, junk bonds can be rated anywhere between Baa (BB) and D.” -from the concise encyclopedia of economics

From Fitch Ratings via Business Wire

July 06, 2009 03:49 PM Eastern Daylight Time  -- NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded the state of California's (the state) long-term general obligation (GO) bond rating to 'BBB' from 'A-'. The bonds remain on Rating Watch Negative. The rating action affects the state's GOs and lease appropriation and related bonds as detailed at the end of this release.

The downgrade to 'BBB' is based on the state's continued inability to achieve timely agreement on budgetary and cash flow solutions to its severe fiscal crisis. Since no agreement was reached by the June 30, 2009 fiscal year (FY) end, the state's controller has now begun issuing registered warrants (IOUs) for certain non-priority payments to preserve cash, and the budget gap to be addressed has increased to $26.3 billion from $24.3 billion. The use of IOUs for non-priority payments would offset cash shortfalls into September 2009 as now currently projected.

The Rating Watch Negative reflects the short-term risk, in Fitch's view, that institutional gridlock could persist, further aggravating the state's already severe economic, revenue and liquidity challenges and weighing on the state's credit. Resolution of the Negative Watch will depend on actions taken to address the cash flow imbalance. The 'BBB' rating indicates that expectations of default risk remain low, although the rating is well below that of most other tax supported issuers. GO debt in California has a constitutional prior claim on revenues, although after education; appropriation debt has a lesser legal claim, but the controller prioritizes payment directly after GO debt service, ahead of other mandatory payments.

With issuance of IOUs for non-priority payments, margins for meeting constitutional and court-required contractual commitments are narrowing. After September 2009, absent any proposed budget and payment adjustments, cash deficits will expand dramatically. Cash flow solutions, including the ability to access short-term borrowing, are inextricably tied to reaching timely agreement on effective and credible budget solutions.

The state's budget revision released in May had forecast a $24.3 billion budgetary gap through June 30, 2010, the end of FY 2010, before proposed solutions; $3.1 billion of proposed solutions were in FY 2009, with the remainder in FY 2010. By failing to reach agreement prior to June 30, 2009, the end of FY 2009, a portion of the $3.1 billion in proposed FY 2009 budgetary solutions has been forfeited; notably, such solutions would have alleviated the cash flow stress forecast in the early months of FY 2010 by reducing or deferring scheduled statutory disbursements, primarily to education. Moreover, under the state's constitutional spending formula for education, foregone FY 2009 proposed solutions lead to higher required spending in FY 2010 and beyond, and pushed the FY 2010 baseline budget gap to $26.3 billion.

The inability of the state to reach agreement has prompted the controller to begin issuing IOUs for non-priority payments, primarily disbursements to vendors, for certain social services, and for tax refunds, in order to ensure payment of priority payments, including GO and lease debt service. The controller's office estimates that $3 billion in IOUs will be issued during July 2009; priority payments of $10.8 billion will be made for education, debt service, Medicaid, payroll, pensions and other mandatory contractual obligations. Projections will be revised to reflect June revenue performance and other changes but as currently estimated, cumulative cash deficits of $3.7 billion are projected through August, offset by $4.5 billion in non-priority payments that could be covered with IOUS, excluding tax refunds. However, by the end of October, the projected cash deficit expands to $16.1 billion, well beyond non-priority spending of only $10.6 billion, excluding tax refunds.

Today's further downgrade to 'BBB' on Rating Watch Negative affects GOs, GO veterans, economic recovery and Cal-Mortgage Loan Insurance Division bond ratings.

Moreover, the following appropriation bonds of the state are also downgraded to 'BBB-' on Rating Watch Negative:

--Public Works Board (except for those issued for the Regents of the University of California);

--East Bay State Building Authority;

--Los Angeles State Building Authority;

--Oakland State Building Authority;

--Riverside County Financing Authority;

--Sacramento City Financing Authority;

--San Bernardino Joint Powers Financing Authority;

--San Francisco State Building Authority;

--Golden State Tobacco Securitization Corporation (series 2005A);

--California Infrastructure and Economic Development Bank state school fund apportionment lease revenue bonds;

--California Judgment Trust;

--Shafter Joint Powers Financing Authority;

--Taft Public Finance Authority.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.

Contacts

Fitch Ratings, New York
Douglas Offerman, +1-212-908-0889
Richard Raphael, +1-212-908-0506
Cindy Stoller, +1-212-908-0526 (Media Relations)
cindy.stoller@fitchratings.com

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