S&P warns California’s credit rating is at risk of another cut

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California’s credit rating, already the lowest among the 50 states, may be hacked again, Standard & Poor’s warned today.

As the debate over budget cuts drags on in Sacramento, S&P put its ‘A’ grade on the state’s $59 billion in general obligation bonds on ‘negative credit watch,’ meaning the rating is at risk of a downgrade.


Using language that could further spook bond investors, S&P said, ‘Although we continue to believe the state retains a fundamental capacity to meet its debt service, insufficient or untimely adoption of budget reforms serve to increase the risk of missed payments in our view.’

The Legislature and Gov. Arnold Schwarzenegger are facing a $24-billion budget shortfall, and Controller John Chiang has warned that the state could run short of cash beginning July 28, just one month into fiscal 2010.

Noting that time is running out, S&P warned:

Both the timing and magnitude of the state’s impending liquidity shortfall raise significant credit concerns, in our view, particularly if the state were to begin fiscal 2010 without having meaningful budget revisions in place. We believe that without budget revisions, the state may need to defer (or issue registered warrants in lieu of making) cash payments for certain lower-priority obligations (such as vendors, student aid, and tax refunds) in order to preserve cash for required payments for education and debt service. Were the state to do this, or if it were to adopt a budget package that relied on assumptions that we regard as too optimistic or that relied on mechanisms for bridging the projected shortfall through at least fiscal 2010 that we regard as unreliable, we may consider lower ratings.

Any downgrade could spur investors to force the state to pay even higher interest rates when it borrows. Market yields on California’s general obligation bonds already have surged in recent weeks as the prices of the bonds have fallen, reflecting investor jitters.

California and Louisiana had been tied for last place, at ‘A-plus,’ on S&P’s state ratings list, until February, when S&P cut the Golden State to ‘A.’ Most states are rated either ‘AA’ or ‘AAA.’

S&P’s latest downgrade warning also applies to its ‘A-minus’ rating on the state’s $8.1 billion of appropriation-backed lease revenue bonds.


-- Tom Petruno