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Summary: California; General Obligation; General Obligation Equivalent Security; Joint Criteria; School State Program

Publication date: 31-Jan-2013 13:11:32 EST

Credit Profile
California GO
  Long Term RatingA/StableUpgraded
California GO
  Long Term RatingA/StableUpgraded
California GO
  Long Term RatingA/StableUpgraded
California GO bnds
  Long Term RatingA/StableUpgraded

Rationale

Standard & Poor's Ratings Services raised to 'A' from 'A-' the long-term ratings and underlying ratings (SPURs) on California's $73.1 billion in general obligation (GO) bonds and $1.9 billion in Proposition 1A bonds. We simultaneously raised to 'A-' from 'BBB+' our long-term ratings and SPURs on the state's $9.3 billion in appropriation-backed lease revenue bonds (excluding $2.39 billion of lease revenue bonds, which were issued by the State Public Works Board for Regents of the University of California projects). The outlook is stable. Finally, we affirmed the 'AAA/A-1+' and 'AAA/A-1' ratings on some of the state's GO variable-rate demand bonds. The long-term component of the ratings is based jointly (assuming low correlation) on that of the obligor, California, and the various letter of credit (LOC) providers. The short-term component of the ratings is based solely on the ratings on the LOC providers.

The upgrades reflect our view of California's improved fiscal condition and cash position, and the state's projections of a structurally balanced budget through at least the next several years. As part of Governor Jerry Brown's recent budget proposal and multiple-year plan, the state would also largely retire its backlog of payment deferrals and internal loans. We view the alignment between revenues and expenditures as much improved and largely a result of policymakers' heightened emphasis on fixing the state's fiscal structure in the past two budgets. This has primarily consisted of programmatic reductions and reforms designed to generate budget savings because, until recently, strongly rebounding tax collections have not accompanied the economic recovery. Now the economic expansion is gaining positive momentum, however. In addition, the voters' approval in November of temporarily higher statewide sales and personal income tax (PIT) rates positions the state to capitalize on burgeoning economic activity and income gains. We believe these factors have worked in concert to help the state reverse fiscal course. As recently as 2011, the state's four year general fund forecast anticipated annual deficits ranging from $17.4 billion to almost $27 billion. Now the Department of Finance (DOF) projects small surpluses through at least fiscal 2017. The projected surpluses would be larger except that, under the governor's proposal, much of the new revenue is dedicated to debt retirement. As of June 2012, the state was carrying about $33.5 billion in various budget liabilities in the form of deferred payments and interfund loans.

We view the current and proposed budgets as placing the state's finances on a more sustainable trajectory. When the state adopted its fiscal 2011 state budget, the DOF forecast general fund spending in fiscal 2014 of $112.6 billion, or 15.3% more than what the governor currently proposes. Actual spending has also been reduced. Current year general fund spending -- as well as that proposed for fiscal 2014 -- is lower than what the state spent six years ago, in fiscal 2007.

Strengthening revenue performance is also quickly alleviating the state's cash-related stress and is helping eliminate its need to rely on extraordinary cash management measures. Cash and unused borrowable resources are now approaching pre-recession levels. As with its projected budget surpluses, the state's general fund cash recovery would be more pronounced were it not for the redirection of much of the new revenue to reverse payment deferrals.

Key rating factors supporting the 'A' rating include our view of California's:

  • Deep and diverse economy, which is capable of above-average growth rates partly because of its prominent higher education institutions and businesses in innovative sectors, which help position California as a leading venture capital recipient state;
  • Recent commitment to reaching alignment between ongoing revenues with recurring expenses while paying down budgetary debts;
  • Likelihood for regular enactment of timely budgets following a constitutional change requiring only a legislative majority for budget approval; and
  • High but conservatively structured bonded debt.

Somewhat offsetting these strengths is our opinion of the state's:

  • Volatile revenue base, which, because of its highly progressive income tax structure, is linked to difficult-to-forecast financial market performance;
  • Potential for structural budget balance to erode when the recent voter-approved tax hikes fully expire in seven years or sooner if the legislature were to increase ongoing spending; and
  • Large retirement benefit and budgetary liabilities although, in the case of the latter, there is a well-developed plan for extinguishing the remaining balances due (the budget liabilities constitute the state's large negative fund balance, on an audited basis, of $20 billion, or about 20% of general fund expenditures).

The state's general fund serves as the source of all GO bond repayment, to which the state has pledged its full faith and credit. State funding to the public kindergarten through grade 12 school systems and institutions of higher education is the only obligation that, according to the state's constitution, has a higher priority than GO debt service payments. The state's debt obligations are paid in the following order: GO bonds, Proposition 1A bonds, and lease- and appropriation-backed debt.

We see several factors that could affect whether and how much the state's credit quality strengthens from its current rating level. Although its finances are on the mend and its liquidity is much stronger, we continue to view the state's budget repair effort as a work in progress. A central question going forward is whether actual financial performance can match -- or at least approach -- the outcomes targeted in the governor's budget proposal and multiple year forecast. In the near term, we see economic and revenue performance as key to the state's ability to realize a more stabilized budget. But another part of the answer likely rests with state lawmakers. Given that fiscal restraint has been a crucial ingredient to the state's strengthening financial position, we think the budget process itself contains some risk. After implementing significant program cuts in consecutive years, we anticipate there could be political pressure to restore services that would entail higher costs and could undermine the state's nascent fiscal balance. We also believe there is potential for windfall-like PIT collections through the early months of 2013, reflecting robust capital gains from 2012. Initial January tax receipt data suggest a surge of PIT collections may already be underway. A temporary flood of revenue could embolden lawmakers that may already prefer to add back to state programs. Alternatively, a faltering economy -- the other main threat to the state's improving situation -- could open a new fiscal gap, requiring another round of austerity.

But even if the economy does its part, spending restraint will likely remain crucial in order for the state to achieve the fiscal results suggested by the governor's four year forecast. Notably, the governor's plan goes beyond maintaining general fund balance and envisions paying down $28 billion in existing budget liabilities (the projected balance at June 30, 2013 on the state's so-called "wall of debt"). We believe that eliminating these liabilities according to the governor's schedule is important because the last of the higher tax rates under Proposition 30 will expire in December 2018. As it is, the budgetary debts undermine the state's ability to tackle other long-term impediments to credit quality -- such as its retirement liabilities. In particular, the state's pension system for teachers (CalSTRS) is chronically underfunded from an actuarial standpoint and, at some point, will likely require higher contributions from the state. The budget liabilities generally, and the $11 billion of payment deferrals in particular, crowd out such uses of revenue. In effect, the backlog of deferrals means that a significant share of current year spending goes to paying for prior year expenses. We expect that the range of possibilities for the state's credit rating would extend higher once it is free of this inflexibility.

Other medium- to long-term credit factors involve the composition of state revenues. First, the state will face transitioning to a post-Proposition 30 revenue environment. Using the enhanced tax revenue to pay down the wall of debt, as recommended by the governor, instead of increasing programs would ease somewhat the phasing out of this revenue. Longer term, we believe fiscal reforms that reduce the detrimental effects of PIT volatility on the general fund also would be beneficial to the state's credit quality. The state's retirement benefit liabilities are also a negative long-term rating factor. Based on the analytic factors we evaluate for states, on a four-point scale in which '1' is the strongest, we have revised California's composite score to 2.6 from 2.7.

On a four-point scale in which '1' is the strongest, we have revised California's overall financial management score to 3.0 from 3.5 and its budgetary performance score to 2.6 from 3.0. We also changed the state's debt and liability profile score to 3.6 from 3.5.

The other scores are unchanged from our full analysis of Sept. 14, 2012.

Outlook

The stable outlook reflects our view of the state's credit quality in light of a stronger budgetary and cash position during the next year. However, we also see potential for further upward rating movement pending economic and revenue performance. Improvements in the fiscal projections planned in the governor's budget proposal, such as progress paying down the budget liabilities, are likely to influence the state's potential for additional upward movement. Conversely, renewed downward rating pressure could occur if significant structural deficits and liquidity pressures return. In addition, global and macroeconomic risks -- particularly stemming from federal fiscal consolidation -- generally pose a threat to the state's economy and fiscal position. Therefore, a potential downturn could have negative credit implications for the state depending upon its severity.

Related Criteria And Research

Ratings Detail (As Of 31-Jan-2013)
California go adj rate bnds (wkly interest rate) ser 2003 C-3 & C-4
  Long Term RatingAAA/A-1Affirmed
  Unenhanced RatingA(SPUR)/StableUpgraded
California go adj rate bnds (wkly interest rate) 2003 B-1 thru B-4
  Long Term RatingA/StableUpgraded
California various purp go bnds dtd 02/01/2004 due 02/01/2005-2029 2033-2034
  Unenhanced RatingA(SPUR)/StableUpgraded
California various purp GO bnds dtd 04/01/2004 due 04/01/2005-2031 2034
  Unenhanced RatingA(SPUR)/StableUpgraded
California various purp GO bnds & GO rfdg bnds dtd 02/01/2007 due 12/01/2007-2029 2032-2036
  Unenhanced RatingA(SPUR)/StableUpgraded
California various purp GO bnds & GO rfdg bnds dtd 02/01/2007 due 12/01/2007-2029 2032-2036
  Unenhanced RatingA(SPUR)/StableUpgraded
California var purp go bnds dtd 05/01/2003 due 02/01/2008-2028 2032 2033
  Long Term RatingA/StableUpgraded
California var purp GO bnds
  Long Term RatingA/StableUpgraded
California var purp GO bnds
  Long Term RatingA/StableUpgraded
California GO adj rate bnds (weekly interest rate) ser 2003 C-1 dtd 04/15/2003 due 05/01/2033
  Long Term RatingAAA/A-1Affirmed
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO bnds dtd 02/01/2003 due 02/01/2008-2027 2029 2031 2033
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO bnds (daily interest rate) ser 2003 A-1
  Long Term RatingAAA/A-1Affirmed
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO bnds (daily interest rate) ser 2003 A-2 & A-3
  Long Term RatingAAA/A-1Affirmed
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO rfdg bnds (SIFMA index fltg rate bnds) ser 2012A due 06/01/2033
  Long Term RatingA/StableUpgraded
California GO rfdg bnds (SIFMA index fltg rate bnds) ser 2012B due 05/01/2020
  Long Term RatingA/StableUpgraded
California GO VRDB prog
  Long Term RatingAAA/A-1+Affirmed
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO VRDB prog
  Long Term RatingAAA/A-1+Affirmed
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO VRDB prog ser 2005B-3 dtd 11/17/2005 due 05/01/2030
  Long Term RatingAAA/A-1Affirmed
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO VRDB prog ser 2005B-5
  Long Term RatingAAA/A-1Affirmed
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO VRDB prog ser 2005B-5
  Long Term RatingAAA/A-1Affirmed
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO VRDB prog ser 2005 A-1-1 dtd 11/17/2005 due 05/01/2040
  Long Term RatingAAA/A-1+Affirmed
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO VRDB prog ser 2005 A-2-1 dtd 11/17/2005 due 05/01/2040
  Long Term RatingAAA/A-1Affirmed
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO VRDB prog ser 2005 A-3 dtd 11/17/2005 due 05/01/2040
  Long Term RatingAAA/A-1Affirmed
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO VRDB prog ser 2005 B-1 dtd 11/17/2005 due 05/01/2040
  Long Term RatingAAA/A-1Affirmed
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO VRDB prog ser 2005 B-2 dtd 11/17/2005 due 05/01/2040
  Long Term RatingAAA/A-1Affirmed
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO VRDB prog ser 2005 B-4 dtd 11/17/2005 due 05/01/2040
  Long Term RatingAAA/A-1Affirmed
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO VRDB prog ser 2005 B-7 due 05/01/2040
  Long Term RatingAAA/A-1Affirmed
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO (wrap of insured) (AMBAC & AGM) (SEC MKT)
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO (wrap of insured) (AMBAC & BHAC) (SEC MKT)
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO (wrap of insured) (AMBAC) (ASSURED GTY) (SEC MKT)
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO (wrap of insured) (FGIC & AGM) (SEC MKT)
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO (wrap of insured) (FGIC & BHAC) (SEC MKT)
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO (wrap of insured) (MBIA) (National) (AGM) (SEC MKT)
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO (wrap of insured) (MBIA) (National) (ASSURED GTY) (SEC MKT)
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO (wrap of insured) (SYNCORA GTY) (BHAC - SEC MKT)
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO (ASSURED GTY) (SEC MKT)
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO (MBIA) (National) (SEC MKT)
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO (MBIA) (National) (SEC MKT)
  Unenhanced RatingA(SPUR)/StableUpgraded
California VRDB (Kindergarten-Univ Pub Ed Fac proj) ser 2004 A-1
  Long Term RatingAAA/A-1Affirmed
  Unenhanced RatingA(SPUR)/StableUpgraded
California (Kindergarten-Univ Pub Ed Fac proj) VRDO ser 2004 A-5
  Long Term RatingAAA/A-1Affirmed
  Unenhanced RatingA(SPUR)/StableUpgraded
California (Kindergarten-Univ Pub Ed Fac) VRDO ser 2004B1-B4
  Long Term RatingAAA/A-1Affirmed
  Unenhanced RatingA(SPUR)/StableUpgraded
California (Kindergarten-Univ Pub Ed Fac) VRDO ser 2004 A - 6
  Long Term RatingAAA/A-1Affirmed
  Unenhanced RatingA(SPUR)/StableUpgraded
California (Kindergarten-Univ Pub Ed Fac) VRDO ser 2004 A-7
  Long Term RatingAAA/A-1Affirmed
  Unenhanced RatingA(SPUR)/StableUpgraded
California (Kindergarten-Univ Pub Ed Fac) VRDO ser 2004 A-8
  Long Term RatingAAA/A-1Affirmed
  Unenhanced RatingA(SPUR)/StableUpgraded
California (Kindergarten-Univ Pub Ed Fac) VRDOser 2004 A-4
  Long Term RatingAAA/A-1Affirmed
  Unenhanced RatingA(SPUR)/StableUpgraded
California (Kindergarten-Univ Pub Ed Fac) VRDO ser 2004 A-10
  Long Term RatingAAA/A-1Affirmed
  Unenhanced RatingA(SPUR)/StableUpgraded
California (Kindergarten-Univ Pub Fac) VRDO ser 2004B-5&B-6
  Long Term RatingAAA/A-1+Affirmed
  Unenhanced RatingA(SPUR)/StableUpgraded
California GO
California GO (AGM)
California GO (AMBAC)
California GO (ASSURED GTY)
California GO (CIFG Assurance)
California GO (FGIC) (National)
California GO (MBIA) (National)
California GO (Syncora Gty)
  Unenhanced RatingA(SPUR)/StableUpgraded
California Infrastructure & Econ Dev Bnk, California
California
California Infrastructure & Economic Development Bank, state sch fd apportionment lse rev rfdg bnds (Oakland Unif Sch Dist Fincg)
  Long Term RatingA/StableUpgraded
California Infrastructure & Econ Dev Bnk (California) state sch fd apportionment lse rev bnds (King City Jt Un High Sch Dist Fincg) ser 2010
  Long Term RatingA/StableUpgraded
California Infrastructure & Economic Dev Bank (California) st sch fd apportionment lse rev bnds (Vallejo City Unif Sch Dist Fincg)
California Infrastr & Econ Dev Bank (California) st sch fd apport lse rev rfdg bnds (Vallejo City Unif Sch Dist Fincg) (FGIC) (MBIA of Illinois)
  Unenhanced RatingA(SPUR)/StableUpgraded
California Infrastructure & Economic Dev Bank (California) st sch fd apportionment lse rev bnds (West Contra Costa Unif Sch Dist Fing)
California Infrastr & Econ Dev Bank (California) st sch fd apportmnt (West Contra Costa Unif Sch Dist Fing) (FGIC) (MBIA of Illinois)
  Unenhanced RatingA(SPUR)/StableUpgraded
California Statewide Communities Dev Auth, California
California
California Statewide Communities Dev Auth (California) rev bnds (Prop 1A Prog) ser 2009
  Long Term RatingA/StableUpgraded
Many issues are enhanced by bond insurance.

Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.

Primary Credit Analyst:Gabriel J Petek, CFA, San Francisco (1) 415-371-5042;
gabriel_petek@standardandpoors.com
Secondary Contact:David G Hitchcock, New York (1) 212-438-1000;
david_hitchcock@standardandpoors.com

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