California ratings hold, so far, as coronavirus smashes state budget
California's state bond ratings and outlooks, buoyed by record growth in the state's reserves, have held steady, so far, even as lawmakers wrangle over steep budget cuts in response to the coronavirus pandemic.
The state is rated AA, Aa2 and AA-minus by Fitch Ratings, Moody’s Investors Service and S&P Global Ratings, respectively, after two upgrades during 2019. All assign stable outlooks.
Analysts are keeping a close watch on the state as lawmakers debate the budget for fiscal year 2021, but are cautiously optimistic that the Legislature and Gov. Gavin Newsom will take the steps necessary to ride out a pandemic-induced recession.
The Legislature released an outline last week of plans to avoid cuts Newsom proposed in May. The proposal released by the state’s Democratic leaders came 12 days ahead of the June 15 deadline for them to pass a budget, or forego pay.
“We will have to take a look at the Senate bill when it actually comes out,” David Hitchcock, an S&P analyst, said in an interview. “We don’t know what will be enacted. The Legislative Analyst’s Office has done some published analysis on it, but even now some of the details are being worked out.”
The sticking points between the governor and the Legislature are over how to manage spending on the coronavirus pandemic, how far the state should go to help undocumented immigrants, and how much to cut schools and safety net programs if the federal government doesn’t approve additional funding.
Lawmakers criticized Newsom for an over-reliance on federal funding in his revised budget.
“We prioritized vital safety net programs and restored many proposed cuts because we cannot leave working families behind, as we forge a path to economic recovery,” Assemblymember Phil Ting said in a statement. “This shared fiscal plan gives us momentum to pass a balanced, on-time budget by the June 15th deadline.”
The governor proposed slashing $14 billion from schools, health care and safety net programs unless the federal government approves additional funds by July 1. The Legislature’s proposal assumes federal funding will be approved, and if it doesn’t arrive by Oct. 1, would limit cuts to $7 billion by drawing on reserves.
S&P’s stable outlook “reflects our expectation that California will have adequate liquidity to ride out the current recession, and that the state’s economy will at least partially bounce back after the pandemic restrictions are lifted,” Hitchcock wrote in a report he co-authored that was published Thursday.
Fitch and Moody's both affirmed ratings and outlooks in mid-April, after the pandemic hit.
Future credit quality will depend on the state's ability to come up with structural budget solutions in the out-years, Hitchcock said.
If what Newsom proposed in the May revision were implemented, the state would have an out-year budget gap of $6.5 billion in 2022 under its multi-year budget projections, Hitchcock said. That equates to 4.8% of projected expenditures, and it assumes a certain amount of growth in revenues, and so forth, he said.
That gap would be lessened, however, if Newsom scraps his proposal to increase to 40% from 38% Proposition 98 minimum funding for K-12 schools, Hitchcock said. That proposal would add an additional $1.8 billion in spending, he said.
The $19.3 billion that Newsom cut from his January budget during the May revision is about 14% of expenditures in 2021, the Senate bill would add another 2% to 3% of one-time adjustments and deferrals, Hitchcock said.
“They have historically had a relatively good handle on expenditures,” Hitchcock said. “It’s a large state with a lot of people in the Department of Finance, who look at all aspects of the budget. It’s both a product of them being able to identify potential cuts, and the political willingness to make the cuts, so we will see how the process ends up.”
S&P also noted in the report that California has untapped debt resources.
Right now, state leaders have not indicated they would do any cash-flow financing, but the state is in a good position in terms of cash-flow, Hitchcock said.
“At the end of April, the state controller’s report said they had $38.8 billion of unused borrowable resources, which is pretty large," he said.
That number will likely be reduced because of the anticipated pandemic-driven recession, however.
With income tax filings postponed into July, the state is estimating receiving an additional $15 billion, he said.
“April is usually the cash flow high point, but now it may be the low point,” Hitchcock said. “They will still have a relatively high internal borrowable cash position going into fiscal 2021. I don’t know if they will issue cash flow notes next year, but they are in relatively good shape from a cash perspective.”
In terms of long-term borrowing, the state is projecting $10.6 billion in reserves for fiscal year 2021 under the governor's proposal, equal to 8% of cash expenditures, he said.
The governor’s proposal would result in a positive balance, but that is not the case with the Senate draft bill, he said. “The Senate reserve would still be good, but it includes deferrals, which rely on borrowing cash from other areas, which they currently, do have a lot of.”
“Our focus is going to be on how they solve the structural deficit going into 2022,” Hitchcock said. “It looks like they will be able to get through 2021, but in 2022 they will have to take additional action. So our focus will be on their ability to solve the structural deficit in 2022.”