Calif. Removed From Negative Credit Watch

Fitch Ratings on Monday removed California from its “negative credit watch” list, saying with a budget in place the state’s financial condition is unlikely to deteriorate further.

“Movement toward financial stability is anticipated,” now that a $105-billion budget has been adopted a month late, the Wall Street credit-rating firm said in its announcement.

But its analysts warned that the budget’s “operating deficit is considerable,” with a projected $5-billion gap between income and spending by the start of the next fiscal year.

Gov. Arnold Schwarzenegger’s first budget, signed July 31, is built on $7 billion in loans and one-time savings.

Fitch is the first of the three major credit rating firms to react to adoption of the state’s new budget. After Schwarzenegger presented his revised budget in May, Moody’s upgraded the state’s rating, while Standard & Poor’s switched the state’s status to “positive credit watch,” meaning a rating upgrade was possible.

Fitch’s move is “another sign of recognition from the financial markets that California is finally turning its financial fortunes around,” said H.D. Palmer, a spokesman for the state Department of Finance.

But Democratic state Treasurer Phil Angelides noted that the announcement leaves California with the nation’s lowest credit rating, and in a statement said the state’s continued deficit spending stunted chances to restore that rating to higher levels.

Fitch rates the state’s general obligation bonds BBB. S&P;’s rating also is BBB, and Moody’s gives the state a rating of A3.

Fitch said future adjustments in the state’s rating would depend not only on the economy but also on state leaders’ spending control and efforts to restore the budget to a long-term balance.

So far, the deficit hole has largely been plugged with more borrowing, including $11.3 billion in economic recovery bonds issued this spring to help bridge a $14-billion gap that Fitch said raised questions over whether the state had enough cash to pay its bills.

Outstanding California general obligation bonds have risen in value since late May, driving down their yields to investors, as market rates overall have fallen.

The average annualized tax-free yield on a Bloomberg News index of 20-year California bonds was 4.79% on Monday, down from 5.36% on May 24.

The yield on a Bloomberg index of 10-year California bonds was 4.08% on Monday, down from 4.76% on May 24.