California Cut From Moody’s Watch List

California got a bit of good news from credit rating firm Moody’s Investors Service on Thursday: Citing expectations that the state’s financial woes are manageable in the near term, Moody’s said it had removed the state’s debt from a watch list for further downgrade.

Moody’s last month cut its rating on California’s general obligation bonds one notch, to A3 -- the fourth-lowest of 10 investment-grade levels. Moody’s said then that it might cut the rating again, pending a review of whether legal challenges would disrupt state plans to issue about $14 billion in bonds to plug part of a $38-billion budget gap.

“We have now concluded that these challenges should be manageable,” Moody’s said.

In the first round of deficit-related borrowing, California next week plans to issue $2.3 billion in bonds backed by future payments the state will receive from tobacco companies under the 1998 settlement between the industry and the states. Moody’s rates the bonds Baa1, barely investment grade.

The firm still has a “negative” outlook on the state’s bonds overall, a warning that the rating could drop over the next two years. The state “will have substantial difficulty” closing an estimated budget gap of $8 billion in the next fiscal year that begins July 1, Moody’s said.

The state probably would have to pay higher rates on its bonds if its credit grade is cut again. But in recent weeks municipal bond yields have been declining with the general slide in long-term interest rates.

A Bloomberg News index of average tax-free yields on 30-year California muni bonds was at 5.17% on Thursday, down from 5.43% on Aug. 15.

Still, in a measure of investors’ worries about the state, California’s 30-year bonds are yielding more than the 5.07% yield on 30-year U.S. Treasury bonds -- a return that is subject to federal income tax.