S&P; Boosts State’s Credit Rating to A

California’s financial outlook got a vote of confidence Tuesday from credit-rating firm Standard & Poor’s, which lifted the state’s bond grade three notches, citing a better economy and the use of long-term borrowing to stave off a potential budget crisis.

Although its revised credit rating still is the lowest among the states, California’s upgrade was good news for owners of its tax-free bonds because the shift could bolster demand for the securities and make them worth more, analysts said.

Taxpayers also may benefit because stronger demand for the state’s bonds could allow it to pay lower interest rates over time.

Standard & Poor’s boosted the rating on about $33 billion of the state’s general obligation bonds to A from a near-junk level of BBB.

S&P; is the third of the three major credit-rating firms to take a brighter view of the state’s finances in recent months. Moody’s Investors Service raised California’s bond rating in May from Baa1 to A3, the first upgrade in almost four years. On Aug. 9, Fitch Ratings said it removed California from its “negative credit watch” list.

Credit ratings are a shorthand way to gauge a state’s relative financial health. In California’s case, the deepening budget deficits of recent years had left rating firms, and many investors, fearful that the state could face a sudden “liquidity” crisis -- meaning its short-term money needs could become so large that they would scare investors away, similar to what New York City faced in the mid-1970s.

If the state’s rating had been cut to BB, its debt would have been considered a speculative investment, giving it the so-called junk label. Many institutional investors might have been precluded from buying California bonds at that rating.

In its upgrade announcement Tuesday, S&P; said the state’s sale of $11.3 billion in deficit-plugging long-term bonds in spring, as approved by voters, allowed an “easing of immediate liquidity pressure” because the proceeds were used to pay off short-term debt.

With that risk addressed, a 2004-05 budget in hand and the economic outlook improving, a BBB rating seemed “too harsh” to maintain for California, given its huge economy and tax base, said S&P; analyst David Hitchcock in New York.

State Department of Finance spokesman H.D. Palmer said the upgrade was “a strong message of confidence in both California’s economy and the state’s new fiscal direction toward structural balance.”

However, state Treasurer Phil Angelides, who is expected to seek the Democratic nomination for governor in 2006, said that although “it is always good news to hear that the state’s credit rating has improved,” California’s fiscal health “will not be fully restored until the budget is truly balanced and the state’s deficit spending is brought to an end.”

Angelides said the state’s continued reliance in the new budget on long-term borrowing to finance gaps between revenue and spending “places us in continued jeopardy.”

Hitchcock said S&P; recognized that the state’s shift from heavy short-term borrowing to long-term borrowing to fill 2004 and 2005 budget holes “does not mean that the debt has gone away.” But he said the shift gave the state breathing room, and in the meantime an improving economy was raising tax revenue.

“The budget will likely enable the state to avoid substantial further short-term borrowing to fund deficits at least through fiscal 2006,” ending June 30 of that year, Hitchcock said.

California’s debt restructuring “puts time on their side,” said Robert Pariseau, manager of the USAA California bond mutual fund based in San Antonio.

The next move in the credit rating may depend in part on how the state addresses what S&P; noted were “promises made to substantially increase funding for local governments, schools and higher education institutions” in fiscal 2006-07.

Those increases were part of the budget deal struck in July between Gov. Arnold Schwarzenegger and the Legislature.

Dean Gestal, a managing director at bond underwriting firm Stone & Youngberg in San Francisco, said that the risk of future deficits made it unlikely that the state’s credit rating would get another lift anytime soon.

With the upgrade, California is back to the where it stood 13 months ago, when S&P; slashed the rating three notches amid a budget crisis and as then-Gov. Gray Davis faced a recall vote.

California still has the poorest credit grade of all 50 states. The next-worst grade is Louisiana’s A-plus rating.

Institutional investors use credit ratings in part to determine what interest rate they are willing to accept when a state borrows. Higher-grade states pay much lower rates than poorly graded states, because the risk that a state might be unable to pay its debts is less if the current fiscal picture is strong.

Lower interest rates mean taxpayers shell out less over time to pay the cost of bonds used to finance infrastructure projects such as roads and schools.

Yields on California bonds have come down in tandem with other long-term rates since June. Some investors have rushed to lock in bond yields on the assumption that the U.S. economy might slow sharply because of high oil prices. But California still pays much more than other states to borrow.

The average annualized yield on a Moody’s index of Aaa-rated 10-year municipal bonds was 3.54% at the end of last week.

By contrast, the average yield on 10-year California general obligation bonds was 4.08%, a Bloomberg News index shows.

Municipal bond interest is exempt from federal income tax and usually from state tax for residents of the issuing state, so the true returns to investors can be much higher, depending on an investor’s tax bracket.

S&P; on Tuesday also boosted its grades on $7.3 billion of the state’s lease revenue bonds, such as those issued by the Public Works Board, and on $2.6 billion of tobacco bonds.

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Big states’ ratings

Here are general obligation bond ratings for the 10 most populous states. On Moody’s scale, a number rating of 1 is highest within a particular letter grade.

*--* State (by pop.) S&P; Moody’s California A A3 Texas AA Aa1 New York AA A2 Florida AA+ Aa2 Illinois AA Aa3 Pennsylvania AA Aa2 Ohio AA+ Aa1 Michigan AA+ Aa1 Georgia AAA Aaa New Jersey AA- Aa3

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Source: Bloomberg News