News in The Bond Buyer that a few small issuers used reserve funds or bond insurance to pay debt service adds to concerns that a big-name issuer struggling with budget problems may be next. Then it would be news in the general press, which might lead safety-conscious investors to question whether they should own municipal bonds.
But fiscal stress doesn’t necessarily mean default is around the corner. Instead, it often serves as a signal to issuers to make sure that default, if it ever happens, is the last consequence of fiscal stress.
California is a good example. The economic downturn has taken its toll on state budgets, and California is no exception. It must plug a $19 billion deficit, and has started the new fiscal year without a budget agreement. Yet, without downplaying the challenges, it’s useful to review the steps California has taken and the tools it has to manage its finances until it gets a budget.
The state’s liquidity has improved over the last year. California currently has no short-term debt outstanding. The $8.8 billion of revenue anticipation notes it issued last year were fully repaid on June 23. According to the state controller, California had $8.76 billion of cash resources available to the general fund on June 30, an increase from $7.13 billion a year earlier. These resources will help the state manage if there is a protracted budget delay.
If these resources prove insufficient, that doesn’t necessarily threaten debt service. Most operations would have to shut down before the state was unable to pay bondholders, given the high priority debt service commands under the state constitution.
One reason for the increase in cash resources is California’s success addressing last year’s deficit. In 2009-10, on a cash basis, general fund receipts exceeded disbursements by $2.0 billion. In comparison, they fell short by $10.5 billion the prior year. Modest growth in receipts of $880 million was one factor, but more important was an $11.6 billion decrease in disbursements — a 12% drop. The state made major cuts to spending on education, corrections, and health and human services.
California manages its cash needs with Rans. It has issued them every year for several decades, except once at the height of the dot-com boom. The notes are cash-flow debt to match the even pattern of expenditures with the uneven receipt of revenues. They are not used to finance or roll over a budget deficit. In fact, because they must be issued and repaid within the same fiscal year, they can’t be rolled over with the next year’s Rans, which can’t be issued until the next fiscal year begins.
Although the state receives relatively little revenue in the summer, cash resources at the beginning of the year delay the necessity to issue notes until September or October. And, interestingly, a budget delay helps preserve cash because certain payments are not authorized in the absence of a budget. These include payments to local governments and vendors who provide services to the state, and some payments to schools.
Debt service still can and must be paid.
According to California’s controller, the lack of a budget this year would delay until the end of September the date when the state is unable to make all payments. By then, officials hope to issue Rans. But it can only do so if a budget is in place.
While the state budget is often late, it has been delayed beyond August only once in the last 30 years, and that was in 2008 when the budget passed on Sept. 16. If the state still has no budget by the end of September, it can turn to other cash-management tools.
Revenue anticipation warrants are one such tool. They are a cash borrowing that differs from Rans in two important ways: Raws can be issued in the absence of a budget, and can (but need not) be repaid in the following fiscal year. They could be used like Rans to provide cash within the fiscal year, or, if repaid the next year, could both provide cash and reduce the steps needed to solve the deficit in the year they are issued.
Governors can be reluctant to use warrants because they can take pressure off the Legislature to enact a budget. The state last issued them in 2003, and Gov. Arnold Schwarzenegger has been silent about their use this year. Although the controller issues Raws, the governor must authorize them.
Another cash-management tool is to delay making payments. Legislation enacted earlier this year authorizes certain payment deferrals that will produce cumulative cash flow benefits to the state of about $4 billion by the fall. These payments must be made up later in the year when it is expected that the state will have issued Rans.
One method of deferment is to issue registered warrants, more commonly known as IOUs. The state issued 450,000 IOUs worth $2.6 billion between July 2 and Sept. 4, 2009. In the absence of a budget, though, IOUs have little punch because they can generally be used only for the types of payments that are already prohibited when there is no budget. Their use last year occurred after enactment of the 2009-10 budget, which was approved several months early in February 2009.
While California’s finance officials wait for a budget, they have many tools and resources at their disposal to manage state operations and ensure not only that debt service is paid, but that state operations also proceed uninterrupted.
Paul Rosenstiel is the manager of the San Francisco office of De La Rosa & Co. and was California deputy treasurer from 2007 to 2009.