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California maintains A-plus credit rating after IOU sale

October 21, 2008 |  5:29 pm

Individual investors' ravenous appetite for the short-term IOUs California sold last week helped the state avoid a potential credit-rating downgrade.

Standard & Poor's today affirmed its A-plus grade on the state's general obligation debt and called the rating outlook stable, after California raised $5 billion via short-term notes to patch its seasonal budget shortfall.

S&P on Oct. 10 had warned that the rating (already the lowest for any state; most are rated AA or AAA) would be in jeopardy if Sacramento couldn't sell IOUs to raise needed cash. Because the credit crunch had scared most investors out of the municipal bond market in the last two months, it was looking as if California wouldn't find enough takers for its debt.

California_state_flag But individual investors turned out in force for the deal, lured by the high tax-free yields the state offered: 3.75% on seven-month notes and 4.25% on eight-month notes. With $3.9 billion in orders from individuals alone, the state was able to boost the total size of the offering from $4 billion to $5 billion (institutional investors bought the extra $1 billion).

Treasurer Bill Lockyer is expected to float an additional $2 billion of short-term notes, possibly as soon as next month.

S&P said the $5 billion raised last week provided "what we consider to be sufficient cash and borrowable resources, under current economic conditions ... to enable the state to operate its general fund through the fiscal year ending June 30, 2009."

But given the risks in the economic outlook, with the housing sector still sinking, does California really warrant even an A-plus credit grade?

Here's what S&P says:

Standard & Poor's believes that the state will manage through the current fiscal stress. Our A-plus rating reflects what we see as the long-term fundamental strength of the economic base and our expectation that the state will continue to adequately manage its financial performance and modest debt levels. California has a long history of managing through strained financial conditions; the state typically deficit-borrows when needed. Given the depth and breadth of the economic base, at 13% of the U.S. GDP, the state typically grows out of fiscal stress over time.

Let's hope S&P is more correct on this call than it was about the creditworthiness of many subprime mortgage bonds.