State OKs Sale of $12.3 Billion in Deficit Bonds

State officials on Tuesday quickly authorized the sale of $12.3 billion in deficit bonds, setting the stage for the largest municipal bond offering in U.S. history.

Proceeds from the sale of the bonds will allow California to refinance short-term debt that comes due in mid-June. That money was borrowed last fall to cover some of the state’s deficit spending in recent years.

At the start of a brief bond financing committee meeting, state Finance Director Donna Arduin expressed her gratitude to California voters for last month’s passage of Proposition 57. The measure allows issuance of $15 billion in deficit bonds. The debt is to be repaid over a maximum of 18 years.

An estimated $7 billion in bonds carrying a fixed interest rate will be sold May 4. An additional $5.3 billion in bonds with a variable interest rate are scheduled to go on sale between May 24 and June 15.

“The effect of our actions today will be to refinance our short-term debt at the best rates we can get in the market,” Arduin said.

Arduin, other Schwarzenegger administration officials, and representatives of the state treasurer and controller hope that Wall Street will give a stronger rating to the deficit bonds than the one that Standard & Poor’s rating agency assigned Tuesday to the state’s general obligation debt.

The BBB rating is the lowest of any state in the nation. Generally, the lower the rating, the greater the risk to investors and the higher the cost of borrowing.

Officials believe the deficit bonds will receive a higher rating because the primary source for repayment of the debt will be a quarter-cent of every dollar assessed by the state sales tax.

In announcing its rating, Standard & Poor’s said, “The rating reflects several years of very large operating deficits, a projected deficit in the current fiscal year and projections of a large structural gap in future years between ongoing revenues and expenses” unless the Legislature acts to close the gap. “The rating is as low as it is because the track record has been poor,” said David Hitchcock, director of public finance ratings at S&P; in New York.

Hitchcock cautioned that the borrowing does not solve the long-term fiscal problem that California has faced since the stock market bubble burst four years ago and state revenues plunged.

“Borrowing is the easy part,” Hitchcock said. “Actually adjusting the revenues and expenditures is the hard part. That’s why they take the easy route.”

Hitchcock added, “The state’s increased ability to sell bonds to fund current operations merely postpones difficult taxation or expenditure-reduction decisions.”

The deficit bond sale will eclipse the $11.3 billion in electricity bonds sold to refinance power purchases made during California’s energy crisis in 2000 and 2001. At the time, the power bonds were the largest municipal offering in U.S. history, according to Juan Fernandez, director of the public finance unit in the state treasurer’s office.

Even with the bond money in hand, Republican Gov. Arnold Schwarzenegger and the Democrat-dominated Legislature have much work to do before they can adopt a budget for the coming fiscal year.

Hitchcock noted that the state’s budget deficit of about $14 billion a year has “not appreciably improved compared with the same period last year, despite recent economic improvement.”

Finance Department spokesman H.D. Palmer said the governor and Legislature face a major challenge in the months ahead. “Closing a $14-billion hole isn’t a walk in the park,” he said.

In January, Schwarzenegger proposed reductions in state payments to Medi-Cal providers; sharply higher fees for students at community colleges, state colleges and universities; caps on enrollment in health programs; and cuts in other social services. The governor also is counting on the state reaping a share of Indian gaming revenues and borrowing to make contributions to state pension funds.