NEW YORK (Standard & Poor’s) Nov. 5, 2014–Standard & Poor’s Ratings Services
has raised its rating on the State of California’s general obligation (GO)
debt to ‘A+’ from ‘A’, and raised its rating on the state’s general fund
annual appropriation-secured debt to ‘A’ from ‘A-‘. The outlook on both
ratings is stable.
“The upgrades follow voter approval on Nov. 4, 2014, of a strengthened budget
stabilization account under Proposition 2,” said Standard & Poor’s credit
analyst David Hitchcock. “In our view, the new state constitutional provision
will partially mitigate California’s volatile revenue structure by setting
aside windfall revenue for use during periods when state tax revenue could
fall materially short of forecast,” Mr. Hitchcock added.
The enacted provisions have become part of the state constitution and, as
such, cannot be overridden during the annual budgetary process. California has
had a history of leaving its budget stabilization account (BSA) unfunded until
the current budget year.
The upgrade on California’s general fund appropriation-secured debt follows
the upgrade on the state GO debt. This rating is below the GO rating due to
pledged revenues subject to annual state appropriation.
Other key factors supporting the ‘A+’ GO rating include our view of
California’s:
Diverse economy of 38.3 million people, or 12% of the total U.S.
population;
Recent commitment to aligning recurring revenues and expenses, while
simultaneously paying down budgetary debts, and an improved cash
position;
Timely enactment of budgets following a constitutional amendment
requiring only majority legislative consent to approve budgets, which has
reduced exposure to liquidity shortfalls; and
Moderately high bonded debt.
Somewhat offsetting these strengths are what we consider the state’s:
Volatile revenue base, which is linked to difficult-to-forecast financial
market performance because of a highly progressive income tax structure,
and still relatively modest reserves as a percent of expenditures;
Potential for current structural budget balance to erode when
voter-approved tax hikes fully expire in 2018, or sooner if the
legislature were to significantly increase ongoing spending; and
Large retirement benefit and budgetary liabilities.
The state’s general fund serves as the source of all GO bond repayment, to
which California has pledged its full faith and credit.
The stable outlook reflects our view that California will build a material BSA
fund balance in the coming years under recently passed Proposition 2, and that
it will continue to pay down deferred liabilities and debt in advance of the
2018 expiration of a temporary income tax surcharge. The outlook also reflects
a state financial position at the end of fiscal 2014 that was its strongest
position of the past decade. The paydown of budgetary deferrals could
accelerate if revenues come in ahead of budget, and trigger certain provisions
in the budget. However, reserves are expected to remain slim in relation to
budgeted expenses, while waiting for Proposition 2 to go into effect.
Potential developments that could lead to a positive outlook or upgrade would
include an improved budget process, with a midyear budget review and an
institutional framework for timely midyear corrective budget actions; or a
reduction in the state’s very significant pension, other postemployment
benefits (OPEB), and debt liabilities. A downgrade could occur if significant
structural budgetary imbalances reappeared, potentially due to a sharp decline
in budgeted revenues, or if the state developed cash flow problems. Although
California has recently addressed its teacher pension underfunding, the state
continues to carry a large unfunded OPEB that could prove troublesome if not
eventually addressed.