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Moody's drops state's bond rating below 'A,' may cut more

July 14, 2009 |  4:44 pm

Two out of three major bond-rating firms now agree: California's credit grade should begin with a "B" -- a dismal comment on the state's finances.

Moody’s Investors Service today cut the state’s debt rating two notches, to "Baa1" from "A2," warning that the risk is rising that California could have trouble paying its bondholders if the budget stalemate in Sacramento doesn’t end soon.

The firm said the state remained on its "watchlist" for further downgrades.

Moody’s "Baa1" rating is just three notches above the level at which California’s $59 billion in general obligation bonds would be considered "junk," or no longer investment-grade in quality. Next would be "Baa2," then "Baa3," then the junk rating of "Ba."

Fi-bond-ratings-4 The state has never had a junk rating before, and it may not come to that this time around. It’s highly unlikely that the rating firms want to cut California to junk because of the potential firestorm that could set off in the municipal bond market.

But the firms also don’t want to take the chance of failing to foresee a worsening crisis in the state’s finances.

Moody’s rival Fitch Ratings on July 6 cut its rating on the state's debt to "BBB" from "A-minus." Standard & Poor’s, the other member of the Big Three, still has California at "A."

Most states are rated either "AAA" or "AA." California has since early this year had the lowest credit grade of any state.

From Moody’s today:

"The downgrade reflects the increased risk to the legally or constitutionally required payments ('priority payments') as the state deadlock continues and the controller has begun to make certain payments that are not legally or constitutionally required to be paid on time with IOUs.

"Moody's believes that as the days and weeks go by without enacted solutions to the current cash crisis and the $26-billion budget gap, the risk to priority payments, and eventually debt service payments, is increasing. The downgrade incorporates the risk we believe exists at the current time, as well as the state's inability to solve the current difficulties in a timely fashion."

The firm said that a continued delay in balancing the budget "could result in a further downgrade in coming months." What’s more, Moody’s indicated that a budget resolution wouldn’t necessarily mean a rating upgrade from the current dismal level.

"If the state does take action, we will assess the likely impact of those actions: whether they improve liquidity, whether they improve budgetary balance [and] whether they provide long-term solutions or quick fixes," the firm said.

State Treasurer Bill Lockyer has insisted that California would never default on its bond debt. The state Constitution mandates debt payments, which must come before all other state spending except funding for education.

Despite the budget mess some investors have been lured back to the state's bonds this month, pushing down market yields on the securities.

-- Tom Petruno

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