Fitch Drops California GOs to BBB, Lease Debt to BBB-Minus

SAN FRANCISCO — Fitch Ratings downgraded California’s general obligation bonds two notches to BBB from A-minus, pushing the biggest U.S. state’s lease-backed debt to the lowest investment grade, BBB-minus.

Fitch kept California’s bonds on negative watch, suggesting the state’s lease-backed bonds may fall to junk status if a solution to its budget impasse is not found soon.

“The downgrade to BBB is based on the state’s continued inability to achieve timely agreement on budgetary and cash-flow solutions to its severe fiscal crisis,” the agency said in a release. “The rating watch negative reflects the short-term risk, in Fitch’s view, that institutional gridlock could persist, further aggravating the state’s already severe economic, revenue, and liquidity challenges and weighing on the state’s credit.”

California, which has the lowest state credit rating in the nation from all three major rating agencies, last week began making payments with registered warrants, or IOUs, because state lawmakers could not agree on a plan to close a $26.3 billion budget gap.

California Controller John Chiang is making $3 billion of “non-priority” payments with the IOUs this month, conserving cash for $10.8 billion of priority payments for education, debt service and other priority areas. But Fitch said IOUs will only keep the state afloat until October, when its cash-flow deficit is projected to rise to $16.1 billion and the amount of obligations eligible to be paid by IOUs shrinks to $10.6 billion.

“With issuance of IOUs for non-priority payments, margins for meeting constitutional and court-required contractual commitments are narrowing,” Fitch said in a release. “After September 2009, absent any proposed budget and payment adjustments, cash deficits will expand dramatically.”

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