Regional News

Amid New Stability, California's Budget of Little Interest to Bond Market

SAN FRANCISCO — The process of adopting California's budget is no longer a drama that holds much interest for the municipal bond market as the state's fiscal house becomes sturdier after years of dilapidation.

No more comparisons to Greece.

Gov. Jerry Brown and legislative leaders reinforced that feeling this week when they compromised on a $97.4 billion spending plan without the tumult the state had become known for in past years. The deal is expected to lead to a third on-time budget in as many years, following five years of tardiness.

"If you look back over Brown's administration, he has been a very able politician and he has been able to get things done," said Bud Byrnes, CEO of Los Angeles-based RH Investment Corp., a broker-dealer specializing in California municipal bonds. "The market has recognized it."

Byrnes said California's budget at this point means "nothing" to the market. It's a far cry from the days when headlines about budget delays and unpaid bills spooked some investors.

Yield spreads tell the tale.

The state's yield spreads have steadily narrowed against higher rated debt since Brown took office in 2011. Investors demanded much more yield to buy California bonds during its years of budget gridlock. That gridlock also took a toll on California's bond ratings.

California 10-year general obligation bond yield spread versus triple-A rated debt had shrunk to 47 basis points as of Tuesday compared to 178 basis points on the same date in 2009, according to Thomson Reuters.

In that year, the state suffered through one of its most debilitating budget battles, running short of cash to pay ongoing bills., leading Controller John Chiang to issue $2 billion of IOUs to vendors because the state, without an adopted budget, could not go to the municipal market to sell revenue anticipation notes, used to buffer cash supply ahead of tax collections later in the year. That budget was eventually enacted in late July, almost four weeks after the fiscal year had started.

California voters in 2010 passed Proposition 25, dropping the threshold needed for budget approval in the Legislature to a majority from two-thirds, also requiring lawmakers to forfeit pay if the spending plan bill is passed after a June 15 deadline. The governor must sign the legislation by the end of the fiscal year, June 30.

Before Prop. 25, lawmakers got into prolonged budget deadlocks because members of the majority party, usually Democrats, needed a few members of the minority to cross party lines to approve the budget by two-thirds.

Without that hurdle to clear, there's another early agreement this year between the Legislature and the governor.

On Monday, they reached a deal on key parts of the state general fund spending plan, laying a foundation for an on-time budget.

"The Legislature is doing their job and doing it well. It looks like California will get another balanced budget," Brown said in a statement.

The legislation appears to mostly mirror Brown's $97.4 general fund spending plan proposed in May, which is 3.6% higher than last year's budget. It includes a $1.1 billion reserve, spends $2.3 billion to pay off non-school-related debt, and allocates $4.3 billion for this fiscal year and next to pay back money deferred from schools.

State spending has been bolstered by the passage of statewide ballot measure in November that raised sales taxes and income taxes on the wealthy to help pay for education, the largest expenditure in the budget.

Lawmakers also opted to use Brown's lower budget revenue projections despite a forecast from the nonpartisan Legislative Analyst's Office that expects revenues to be $3.2 billion higher than the governor's estimates.

"Our responsibility is to maintain fiscal balance, and that's exactly what we've done in this budget with a $1.1 billion dollar reserve and more than $4 billion dollars allocated to pay down state debt," said state Senate President pro Tem Darrell Steinberg, D-Sacramento, in a statement. "Within that, we've also found some room to make up for some of the most damaging cuts we were forced to make in past years."

The continued fiscal constraint has led to improved credit ratings over the past year.

Standard & Poor's raised California's GO rating to A from A-minus in January, and Fitch Ratings upped its outlook on the state's A-minus rating to positive in March. Moody's Investors Service rates the state's general obligation bonds A1.

The state still has embedded financial problems, such as the liabilities built up during the years of dysfunction, and exposure to revenue volatility because of a high dependence on personal income taxes heightened even more by the recent tax increase.

Moody's lead California analyst Emily Raimes said the budget on the surface appears to maintain the right course.

"Using the lower estimate would, we believe, be more conservative and increase the likelihood of maintaining any budgeted reserves," Raimes said. "It also sounds like the state is on track to have another on-time budget. After years of late budgets, that's a positive move as well."

However, Gabriel Petek, Standard & Poor's California analyst, noted that the new budget appears to add money to education funding at the expense of paying down debt compared to what Brown proposed in May.

"Bearing in mind that we are looking at this solely from a credit perspective, if the final budget achieves less pay down of the budget liabilities in exchange for higher spending than what the governor had put forward, we would see that as a less favorable outcome," Petek said.




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