B of A Stops Redeeming State’s IOUs : Budget: Many other institutions will quit cashing warrants Friday. Customers will feel bite of fiscal impasse.

Bank of America branches purchased their last state IOUs from customers Tuesday, and many other institutions, including Wells Fargo, will follow the lead of the state’s largest bank at the close of business Friday.

As a result, the state’s record-breaking budget impasse could inflict direct financial pain on thousands of individuals and companies as they find it impossible to cash state-issued registered warrants at their local branches. Most have so far been relatively unaffected by the deadlock.

Operating without a budget since June 30, California has not had the legal authority to borrow money to cover its cash shortage and has been meeting many of its financial obligations with the IOUs, or warrants.

With banks beginning to turn the warrant holders away, among the first to suffer, said state Controller Gray Davis, will be Medi-Cal doctors and other hospital and nursing home workers, who are due to be paid with IOUs dated Thursday and Aug. 14.

Banks do not normally set out to upset their customers, but in this case bankers decided they no longer wanted to provide a cushion for the state’s stalled negotiations. They believe that more pressure on Sacramento could spur Gov. Pete Wilson and the Legislature to enact a budget more quickly.

“If it’s an inconvenience to the banks, too bad. If it’s an inconvenience to a large number of individuals, then it’s hell to pay,” said William M. Reid, president and chief executive of Mechanics Bank of Richmond, northeast of San Francisco. Mechanics Bank has tentatively decided to stop accepting the warrants after Friday.

Since the state began paying its bills with IOUs--about $2 billion worth to date--most individuals have felt few direct effects. Banks have generally cashed the warrants for their regular customers and have borne the administrative burden of processing them and bundling them for eventual redemption by the state, at 5% interest.

But now bankers hope that inconvenienced customers will be outraged enough to call or write their elected officials. Such actions from constituents have been strangely and conspicuously absent as the budget process has dragged on.

Controller Davis said the banks’ action leaves the state on shaky ground.

“There is no road map for how to issue the IOUs after the banks reject them,” he said in a telephone interview. “We’re calling around to find out whether there would be ways to accommodate the people with IOUs,” but so far no suitable alternative has been found.

With many banks no longer accepting IOUs, it is possible that a secondary market will spring up as investment houses or other companies redeem warrants at a discount, holding them for the interest and then cashing them at full value.

Customers of banks that have decided to stop accepting the warrants are being urged to contact branch officials to determine their options. Many will probably be able to draw on existing lines of credit or will qualify for new loans or deferred payments. But they will have to cover interest costs or late fees in such cases.

For individuals who can afford it, those paid in IOUs can hold on to them and later collect the 5% interest, which will be exempt from state and federal taxes.

“The branch managers have discretion,” said Lorna Doubet, a spokeswoman at Wells Fargo, based in San Francisco. “If a customer has a good relationship with us, (he or she) could qualify” for a loan or a line of credit.

The California Bankers Assn. reported Tuesday that about 20 banks large and small have stopped accepting the warrants or will have ceased by early next week, and that number is expected to grow quickly. Most of those banks that are continuing to accept warrants for the next few days are taking only those dated July 31 or earlier.

“Certainly, there’s increasing frustration on (the part of) bankers” about the lack of progress in Sacramento, said Nancy Badely, a spokeswoman for the California Bankers Assn., based in San Francisco. Bank officials were especially chagrined, she added, that the announcement on July 23 by several big banks that they would soon stop accepting the IOUs did not spark strong action in the state capital.

First Interstate Bank, based in Los Angeles, is a notable exception among the big institutions. It is continuing to accept the warrants indefinitely--and is trying to turn the situation into an opportunity. Disenchanted customers of other banks can get three months free checking by bringing in a warrant plus $200 to open a new account. In such cases, the bank will put a two-day hold on the warrant amount.

“We’re putting a little marketing twist here,” said John Popovich, a spokesman.

On Monday, state Treasurer Kathleen Brown began redeeming warrants worth $433 million. More will be slated for redemption each day through Thursday, with $210 million eligible today. Davis earlier had set Aug. 3 through 6 as a “window of opportunity” for redeeming some of the IOUs because the state would have cash from incoming sales tax receipts and other sources.

In addition to paying interest on the warrants, the state is paying about $5,000 each day for newspaper advertisements listing the warrants eligible for redemption.

Brown said some businesses have expressed willingness to accept the warrants as payment for products and services. As a last resort, she added that holders should check with neighborhood check cashers or other services that might arise to meet this new demand. But the treasurer warned that customers should expect to pay a hefty price. Her advice: “Exercise caution.”