California treasurer reports benefits from tightening spreads
California's spreads to municipal market benchmarks have tightened over the past decade and its ratings have risen as the state’s economic and budget conditions improved, according to the state treasurer’s annual debt affordability report.
The state has sold $7.5 billion of general obligation bonds since Treasurer Fiona Ma took office in January, including $5.2 billion that refinanced older, higher-interest rate debt in refundings the treasurer’s report said will save Californians $1.3 billion in reduced debt service costs on a present value basis. The state has averaged $7.7 billion in GO sales annually over the past five years.
“Lower borrowing costs, a favorable interest rate environment, improved ratings, and a continued commitment to building reserves will make California more prepared for the inevitable downturn in the economy,” Ma wrote in the report released Oct. 2.
Fitch Ratings upgraded California’s GO rating in August to AA from AA-minus while maintaining a stable outlook. The state holds an AA-minus rating with a stable outlook from S&P Global Ratings, and an equivalent Aa3 from Moody’s Investors Service, which elevated its outlook to positive in June 2018.
The ratings reflect an upward climb over the past decade. S&P dropped California to A-minus in January 2010. They fell to BBB and Baa1 from Fitch and Moody’s in 2009.
The strength of the state’s credit profile, coupled with the supply-demand imbalance for tax-exempt bonds, contributed to interest rates on the state’s bonds outperforming those of many other municipal issuers across the country in fiscal 2018-19, according to the report.
Trading spreads on California's 30-year bonds to the Municipal Market Data benchmark tightened from a high of more than 150 basis points at year-end 2009 to a low of four basis points in September 2019.
The report also acknowledged that the municipal bond market and prices for the state’s bonds are affected by overall conditions in the debt capital markets as well as factors specific to the state.
Since the state’s last debt report a year ago, the municipal bond market has been significantly impacted by changes in Federal Reserve monetary policy, investors’ outlook on the U.S. and global economies, and rising geopolitical and international trade tensions. In response to these events, along with federal limits to state and local tax deductions that make tax-exempt debt more attractive, short-term tax-exempt municipal bond interest rates have generally risen, while long-term tax-exempt interest rates have generally declined, the report said.
The state has $82 billion in outstanding long-term debt including GOs and lease revenue bonds and $43 billion in unused bonding authority. The state anticipates issuing another $11.4 billion in new money GOs and lease revenue bonds from fiscal years 2019 through 2021.
Debt service payments are expected to increase by $47.3 million in 2019-20 and by $467 million in 2020-21.
California ranks seventh in a ranking of the ten most populous states by Moody’s when debt is viewed as a percentage of gross domestic product with a 3.09% ratio. Texas has the lowest ratio at 0.68% with New York higher than the Golden State at 3.97% and Illinois at 4.25%.
“It is good to see that California's debt-to-GDP ratio is only 3.09%, but this does not include unfunded pension and OPEB obligations. I am also concerned that California has $43 billion in authorized but unissued bonds,” said Marc Joffe, a senior policy analyst with the Reason Foundation. “I think the state should use more of this bonding capacity before asking voters to approve more.”
The annual report is intended to provide policymakers and the public with information on California’s debt profile and the market for California’s bonds to better assist with decisions about incurring debt the in the future.
Decisions around bond sales can affect programs encouraging affordable housing, protection of the environment and education, Ma said.
“By seeking the best debt solutions for those challenges, when applicable, we can ensure that the power of debt, when smartly implemented, can benefit our fellow citizens in a way that is visible, positive, and fair,” Ma wrote.