NEW YORK--()--Fitch Ratings assigns an 'F2' rating to $10 billion in State of California (the state) revenue anticipation notes (RANs):
--2010-11 RANs series A-1;
--2010-11 RANs series A-2.
Par amounts for each series will be determined prior to sale, expected via negotiation on or about Nov. 17, 2010.
--Coverage of maturing notes is based on borrowable resources outside the general fund, rather than the general fund itself. Coverage by borrowables remains good as a result of improved borrowable balances and the state's expansion of borrowable funds in recent years. Severe underperformance in the general fund could strain borrowables.
--The revenue outlook incorporates modest growth in tax receipts corresponding to the state's slow return to economic growth.
--Although the legislature and governor resolved budgetary gaps for the current fiscal year, budgetary strains will remain significant going forward even assuming achievement of enacted solutions. The state generally has been unable to respond quickly to budget underperformance.
--The state has expanded its flexibility to address near-term cash flow weakness, and the state's controller has the power to defer payments or issue IOUs to preserve cash.
KEY RATING DRIVER:
--Continued ability to maintain and access borrowable resources.
The notes are payable from unapplied moneys of the general fund, including transfers and internal borrowing, subject to the prior payment of schools and other priority payments. The notes are not general obligations of the state.
The 'F2' rating on the fiscal year (FY) 2010-11 RANs reflects good coverage of the notes provided by resources outside the general fund that are borrowable for general fund purposes, offset by a weakened though stabilizing economy and the likely continuation of budgetary pressures going forward.
The $10 billion in notes are fixed rate and non-callable, and are expected to be offered in two series maturing by the end of June 2011. Series par amounts and corresponding maturity dates have yet to be determined. The notes are secured by unapplied moneys in the general fund, including transfers and internal borrowing, and subject to prior use for schools and higher education, debt service on GO bonds and commercial paper, and reimbursement of advances to the general fund from special funds as required by law. In addition, the notes carry a back-up pledge of the state to issue revenue anticipation warrants (RAWs) if necessary. The notes are not general obligations of the state.
The state has seen recessionary economic conditions moderate in recent months, with some corresponding stabilization in tax revenues. However, budgetary and cash flow strains remain significant. Despite repeatedly rebalancing its budget over the last three fiscal years in response to revenue underperformance, achieving balance has been complicated by the state's longstanding structural budget imbalance, institutional obstacles to addressing budget and cash challenges, and a contentious political environment. As with recent budget agreements, the $19.3 billion in budgetary solutions enacted in October 2010 for the fiscal year ending June 30, 2011 rely primarily on one-time measures and spending cuts, many of which may not be achieved, and many of which shift revenues from, or expenses into, future periods. The revenue forecast for FY 2010-11 anticipates modest growth tied to a slow economic turnaround. Recent overperformance in personal income and corporation tax collections, contributing to a 6.2% year-to-date positive revenue variance compared to forecast through September, is believed to be due to the timing of payments and is expected to reverse later in the fiscal year.
The $10 billion in notes for FY 2010-11 (which began on July 1, 2010) represent 10.7% of forecast receipts, a higher level than issuance in recent years. However, projected unused borrowable funds after note repayment are nearly $11.1 billion, also higher than recent years, and together with note proceeds provide 2.1 times (x) coverage for the maturing notes. Unused borrowable funds at year-end after note repayment equal approximately 11.8% of cash flow, an indication of the safety margin by which receipts could fall short and still provide 1x coverage on maturing notes without any other action on the part of the state. Despite the state's weak general fund position, actions over the last two years have materially expanded the state's discretion to manage the timing of payments and have augmented borrowable funds available for maturing notes, key factors supporting the note rating.
Cash flow performance began to stabilize late in FY 2009-10. Actual cash receipts of $88.7 billion through June 30, 2010 were 2.3% below the forecast made at the start of the year, a significant improvement from the 14.5% decline between initial forecast and actual receipts experienced in FY 2008-09. Major tax receipts in FY 2009-10 were weaker than expected, with personal income and sales collections down 8.7% and 2.7% from forecast levels, respectively. Actual borrowable resources were more robust than expected, totaling $18.2 billion at year-end, about 8.3% over forecast. As expected, the fiscal year ended without a general fund cash balance and with outstanding temporary loans of nearly $9.9 billion from internal sources, after repayment of $8.8 billion in cash flow notes.
The FY 2010-11 budget, enacted on Oct. 8, forecasts cash receipts rising 5.5% from prior year actuals, to $93.6 billion; personal income and sales tax collections rise 5.2% and 1.8%, respectively. The budget agreement includes significant one-time gap-closing measures, the full achievement of which is uncertain. These include $5.4 billion in additional federal assistance and the completion of a $1.2 billion sale-leaseback transaction for state office buildings. Disbursements rise 4.4%, to $90.5 billion. The year is expected to end without a general fund cash balance and with outstanding loans from internal sources of $6.8 billion. The cash flow forecast assumes use of new cash flow tools to reduce cash flow low points during the year, including an estimated $4.7 billion in one-time deferrals enacted with the budget and as much as $4.8 billion in deferrals allowable under statutory powers enacted by the state in March, 2010.
After sharply declining economic performance during the recession, the state's economy is beginning to improve, albeit at a slower pace than national averages. September 2010 employment was down 0.4% from September 2009, compared to a 0.2% gain nationwide; unemployment in California was 12.4%, versus 9.6% nationally. Personal income has resumed growth, with second-quarter 2010 rising 2.3% year-over-year, compared to a 2.2% gain for the U.S.
For further information, please see Fitch's Rating Action Commentary of Nov. 8, 2010, 'Fitch Affirms California's GO Bonds at 'A-'; Outlook Stable.'
Additional information is available at 'www.fitchratings.com'
In addition to the sources of information identified in the Tax-Supported Rating Criteria, this action was additionally informed by information from IHS Global Insight.
Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria', dated Aug. 16, 2010.
--'U.S. State Government Tax-Supported Rating Criteria', dated Oct. 8, 2010.
--'Rating Municipal Short-Term Debt', dated Oct. 18, 2007.
For information on Build America Bonds, visit www.fitchratings.com/BABs.
Applicable Criteria and Related Research:
Rating Municipal Short-Term Debt
Tax-Supported Rating Criteria
U.S. State Government Tax-Supported Rating Criteria