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California Looking to Short-Term Market

SAN FRANCISCO - In the coming weeks, California is planning to access the short-term debt markets with billions of dollars in revenue anticipation notes.

It will have to convince investors they will be repaid by June on the back of a state budget that has been widely derided as full of accounting gimmicks - or, in the words of the state treasurer who will sell the Rans, a "banana republic budget."

The state, thanks to its boom-and-bust budget cycle, does have experience selling short-term debt under circumstances when its own credit profile is less than ideal. It has issued notes in the past with short-term ratings beneath the highest grade or bought credit enhancement to get the ratings up.

This time, the state is also faced with short-term credit markets roiled with turmoil. That's going to cost California when it comes to market, said Matt Fabian, managing director at Municipal Market Advisors.

"The cost of short-term funding has grown tremendously," he said. "It's not just the index that has risen, but the gaps to the index have risen considerably."

The tax-free money market funds that make up the typical buyer base for notes like the ones California will sell have seen major outflows in recent weeks.

"They're going to have to find non-money market buyers," Fabian said.

State officials haven't said much about how the transaction will proceed.

"We're still proceeding with plans to issue Rans and we'll have a better sense of the size and timing [this] week," state Treasurer's Office spokesman Tom Dresslar said Friday.

Projections earlier this year called for a sale in the $10 billion range.

"We are in the process of reviewing the cash flows and we expect to know the borrowing requirements sometime [this] week," Jacob Roper, spokesman for the state Controller's Office, said Friday. In his most recent monthly cash report, issued Sept. 9, Controller John Chiang said state government would have sufficient cash to make payments through "most of October."

One key question will be the short-term ratings California obtains with a budget that was balanced with gimmicks, many observers said - including state Treasurer Bill Lockyer, who made the "banana republic" comment.

Even in California's last Ran sale, a $7 billion deal last October that obtained top short-term marks, rating reports reflected awareness of cracks in California's cash flow façade. Moody's Investors Service, for example, said its MIG-1 rating was underpinned in part by $3 billion in then-unused deficit bond authorization - now vanished after the state issued the bonds this year when its deficit widened.

"There has been a flight to quality and that's why spreads broadened in that market," Fabian said, referring to the short-term market, "because what was being put was less attractive credits. So a MIG-2 would be a challenge."

The state has sold notes with less than pristine ratings; in October 2002, in the wake of another state budget crisis, it priced $9 billion in Rans that received F1 and SP-1 ratings from Fitch Ratings and Standard & Poor's, respectively, or one notch below their top F1-plus and SP-1-plus ratings. Moody's split its ratings on the deal, assigning MIG-1 and MIG-2 ratings based on their maturity date, with the lower-rated fixed-rate Rans only penalized by 13 basis points, pricing to yield 1.7%.

That deal also saw a mixture of fixed-rate and index notes, another tool the state has used to offer differentiation in large note sales.

That period of budgetary turmoil, which ended only after Gov. Arnold Schwarzenegger persuaded voters to authorize $15 billion in deficit bonds in early 2004, produced other creative financing solutions.

In 2003, the state issued $3 billion in Rans. Of that, $1.835 billion was sold in public debt markets, enhanced by letters of credit from a bank syndicate.

The underwriter, Lehman Brothers, placed the other $1.2 billion privately. Lehman is one of four firms to manage or co-manage California Ran sales since 1998. The other three remain in business, including Banc of America Securities and Goldman, Sachs & Co., underwriters for the upcoming Rans.

Until the deficit bonds were issued in 2004, the state entered a pattern of rolling notes over with more notes, including revenue anticipation warrants, short-term instruments the state issues to bridge different fiscal years.

In June 2003, California sold $11 billion of revenue anticipation warrants, backed by forward purchase agreements with seven investment banks, garnering top-tier short-term ratings.

In 2002, the state sold $7.5 billion in Raws, backed only by standby bid agreements that left them with credit ratings one notch below the highest possible.

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