NEW YORK--()--Fitch Ratings assigns an 'A-' rating to approximately $2.4 billion in general obligation (GO) bonds of the state of California, consisting of:
--$1.09 billion various purpose GO bonds;
--$1 billion various purpose GO refunding bonds;
--$310 million various purpose GO bonds (federally taxable).
The bonds will sell via negotiated sale, with the federally taxable series taking place on March 13 and the tax-exempt series selling on March 14.
Fitch also affirms the 'A-' rating on:
--$228 million GO bonds (stem cell research and cures bonds) series 2009A (federally taxable Build America Bonds)
--$72.7 billion outstanding state GO bonds.
The affirmation of the series 2009A bonds is in conjunction with the remarketing of the series, expected on March 13.
The Rating Outlook is revised to Positive from Stable.
Fitch also takes action on outstanding lease appropriation and other related bonds of the state as detailed at the end of this release.
General obligations, for which the state pledges its full faith and credit, subject to the prior application of moneys to the support of public education; funds for education represent approximately half of state spending.
KEY RATING DRIVERS
POSITIVE OUTLOOK LINKED TO FISCAL PROGRESS: The Positive Outlook reflects the fiscal management improvements instituted by California in recent years, which when combined with two successive years of structural budget progress have enabled the state to materially reduce budgetary borrowing. Eventual rating action would be linked to the state's demonstrated willingness to restrain spending growth and progress reducing budgetary obligations.
WEALTHY, DIVERSE ECONOMY: The economy is wealthy and unmatched among U.S. states in its diversity and breadth. After severe, widespread recessionary conditions, growth has resumed, including in California's housing market.
CYCLICAL BUDGET AND CASH STRESS: State finances have been subject to periodic, severe budget and cash flow crises due to structural imbalances, revenue cyclicality and institutional inflexibility.
VOLATILE REVENUES: Revenues are volatile, notably the component tied to personal income; recently approved temporary tax rate increases further expose the state to personal income tax cyclicality. Modest revenue growth has resumed since the downturn although the course of future collections is uncertain.
TANGIBLE STRUCTURAL PROGRESS: Deep spending cuts in the last two adopted budgets have significantly lowered the state's structural imbalance. Among many challenges to maintaining structural progress is the state's historical inability to achieve and sustain budgeted expenditure reductions.
VOTER INITIATIVES LIMIT FLEXIBILITY: Constraints imposed by voter initiatives and a partisan policy-making environment have repeatedly hindered prompt, effective action on fiscal challenges, although recent budgets have been timely.
MODERATE DEBT BURDEN: Tax-supported debt is moderate, but has grown in the last decade for infrastructure needs and budgetary borrowing. Pension funded ratios have declined and contributions to the teacher system remain inadequate, but the state has instituted some benefit reforms.
Future rating direction will reflect the extent to which the state maintains structural balance, allowing it to apply increased revenues to repay budgetary borrowing. Continued adherence to budgetary discipline would lead to rating improvement. A return to budgetary imbalance, either through unrestrained spending growth or unforeseen economic, revenue or budgetary erosion, could limit or reverse credit momentum.
The Positive Outlook on California's 'A-' GO bond rating is based on the institutional and fiscal progress made to date by the state in recovering from the severe budgetary and cash flow crisis of 2008-2009, and Fitch's expectation that this progress will continue. Notable fiscal management improvements since that time have included stronger cash flow management tools, simple majority budget approval, and two successive years of timely budgets that achieved structural gains primarily through deep, recurring spending cuts.
The temporarily higher personal income tax (PIT) and sales tax rate changes approved by voters last November, while exposing the state to sharper revenue volatility, provide the state with a margin of cash and revenue flexibility to sustain recent progress, including to prioritize reducing the state's burden of budgetary borrowing, estimated at $35 billion in fiscal 2011 in the form of deferrals, internal loans and deficit bonds. The Positive Outlook assumes the state will continue to repay budgetary borrowing and achieve structurally balanced budgets, in particular by resisting spending restorations in the near term.
Despite Fitch's expectation that the state's fiscal situation will improve, California's credit standing is likely to remain lower than most states for the foreseeable future given the magnitude of the state's budgetary and financial challenges. Fitch cautions that years of spending discipline would be necessary to repay budgetary borrowing, even assuming that the state's revenues remain on a steady growth path. The state has few sources of flexibility to confront the inevitable future downturn, and the budget reserve remains empty. Moreover, the impediments to sustainable budget making posed by numerous voter initiatives are unlikely to change. The rating will continue to incorporate the size and breadth of the state's economy and tax base and the strengths inherent in a state's broad powers.
California's economy is unmatched in diversity. Economic recovery is progressing after a particularly deep and protracted recession, although the recovery remains uneven. December 2012 employment is up 1.7% from December 2011, matching the 1.7% national rate for the same period. Employment gains are widespread, particularly in key service sectors, and construction employment has returned to growth. Housing market indicators are likewise improving. California's unemployment rate has fallen considerably in the last year, to 9.8% in December 2012 vs. 11.2% one year earlier, although it remains elevated relative to the nation's 7.8% unemployment rate. Personal income is also growing, with the third quarter of 2012 rising 3.6% year-over-year, compared to 3.2% nationally. The state's latest economic outlook, released with the governor's budget proposal in January 2013, foresees slower economic activity in 2013 given broader macroeconomic uncertainties, after better than expected growth in 2012; stronger growth returns in 2014. The unemployment rate is expected to remain at historically elevated levels.
California fiscal performance in recent decades has been marked by cyclical revenue collections and periodic, severe budgetary and cash flow crises, the resolution of which was often delayed, reliant on non-recurring solutions, and constrained by restrictive voter initiatives. Since the severe fiscal and cash flow crisis of 2008-2009, economic and fiscal recovery has been slow, but the state has made incremental progress in fiscal management. Statutory and administrative changes since early 2009 augmented the power of the state's comptroller, treasurer and budget office to effectively manage state cash resources and avert cash flow crises, and voters in 2010 approved a measure allowing for simple majority approval of state spending plans, rather than the prior requirement for a supermajority.
Additionally, the state's last two budgets, for fiscal 2012 and fiscal 2013, were adopted on a timely basis and incorporated sizable recurring spending reductions, narrowing the state's structural imbalance. The fiscal 2012 budget closed a cumulative gap estimated in January 2011 at $26.6 billion (equal to 15.3% of baseline general fund revenues and transfers at the time). The adopted budget for fiscal 2013, which ends on June 30, closed a gap of $15.7 billion (equal to 17.8% of general fund revenues and transfers). A key component of the adopted fiscal 2013 plan, temporary personal income and sales tax rate increases to generate $5.6 billion in net general fund revenues in fiscal 2013, was endorsed by voters in November 2012; the state benefits from temporary revenues until fiscal 2019.
The governor's proposed budget for fiscal 2014, released in January, anticipates structural balance in the forecast period ending June 30, 2014, with no cumulative gap to close. Despite slightly lower forecast revenue assumptions and the erosion of some adopted budget gap-closing measures, fiscal 2013 remains in balance with a year-end reserve estimated at $167 million, down from the $948 million expected at the time of budget adoption. Fiscal 2013 general fund revenues and transfers rise to $95.4 billion (9.6% over fiscal 2012) given the temporary rate changes enacted in November, and the state repays $6.4 billion in past deferrals and other budgetary borrowing, mostly from general fund resources. Actual revenues year-to-date through January were 10.2% over forecast expectations, although Fitch believes that the overperformance likely reflects acceleration of income into calendar 2012 in advance of recent federal tax law changes and higher liabilities from state tax law changes not underlying trends.
Under the governor's forecast, fiscal 2014 remains in balance, with a reserve of $1 billion expected as of June 30, 2014. The proposal includes only modest revenue and spending policy changes, such as extending two health care-related levies and expanding funding to higher education; the plan also proposes options for expanding health care under recent federal health reform. Revenues and transfers in fiscal 2014 rise to $98.5 billion (3.3% over fiscal 2013). Repayment of budgetary borrowing totals $4.2 billion, about $1 billion less than expected at fiscal 2013 budget adoption. The governor's long-term budget outlook, through fiscal 2017, assumes that the general fund remains structurally balanced and brings the balance of budgetary borrowing down to $4.3 billion, from $27.8 billion forecast as of June 30, 2013.
DEBT AND PENSIONS
California has a moderate but above-average debt burden, with net tax-supported debt of approximately $93.4 billion as of February 1, 2013, equal to 5.7% of 2011 personal income; these figures are adjusted to reflect the bonds to be offered. The debt burden rose over the last decade due primarily to substantial GO bond issuance for infrastructure and borrowing to cover budget gaps. Net tax-supported debt excludes cash flow borrowing; the state issued $10 billion in revenue anticipation notes for fiscal 2013 cash flow needs, which are due May 30 and June 20, 2013.
System-wide funded ratios on a reported basis for the state's two main pension systems, covering public employees and teachers, have eroded due to investment losses. Based on their June 30, 2011 actuarial valuations, the public employees' plan reported an 82.6% system-wide funded ratio and the teachers' plan reported a 69.3% system-wide funded ratio.
Using Fitch's more conservative 7% discount rate assumption, funded ratios for the two systems fall to 78.3% for public employees and 65.7% for teachers. On a combined basis, net tax-supported debt and pension liabilities attributable to the state are estimated by Fitch at 8.8% of 2011 personal income, above the median of Fitch-rated states.
Some reforms to pension contribution levels and benefits were adopted with the state's fiscal 2011 budget, and both systems have reduced their discount rate assumptions, to 7.5%. Full actuarial contributions to the public employees' system are legally required, but not for the teachers' system, leading to persistent underfunding of the latter.
The state adopted a broad package of pension reforms in Sept. 2012 that affect most state and local systems, including through benefit reductions for new workers and higher contributions for employees. While changes are expected to generate only modest near-term annual savings for the state and for local governments whose pension plans are subject to the reforms, annual savings are expected to grow considerably over time.
Today's affirmation of the state's GO rating at 'A-' and Rating Outlook revision to Positive, also applies to the following bonds which are rated on par with the state GO:
--Cal-Mortgage Loan Insurance Division bonds;
--California Statewide Community Development Authority revenue bonds (State of California Proposition 1A Receivables Program).
Appropriation bonds of the state issued by the following entities are affirmed at 'BBB+' with a Positive Outlook, one notch below the state's GO rating:
--Public Works Board (except for those issued for the Regents of the University of California);
--East Bay State Building Authority;
--Los Angeles State Building Authority;
--Oakland State Building Auhority;
--Riverside County Public Financing Authority;
--Sacramento City Financing Authority;
--San Bernardino Joint Powers Financing Authority;
--San Francisco State Building Authority;
--Golden State Tobacco Securitization Corporation (series 2005A).
Appropriation bonds of the state issued by the following entities are affirmed at 'BBB+'; the Rating Outlook remains Stable:
--California Judgment Trust;
--Shafter Joint Powers Financing Authority;
--Taft Public Finance Authority.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
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' (Aug. 14, 2012);
--'U.S. State Government Tax-Supported Rating Criteria' (Aug. 14, 2012).
Applicable Criteria and Related Research
Tax-Supported Rating Criteria
U.S. State Government Tax-Supported Rating Criteria