S&P downgrades one California debt rating, may cut more

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California’s credit rating has been dinged by Standard & Poor’s as the state’s budget crisis worsens.

The rating on $5 billion of short-term notes the state sold in October was cut one notch, from SP-1 to SP-2.

S&P also warned that its A-plus rating on $46.6 billion of California general obligation bonds could be downgraded.

With the state already tied with Louisiana for the lowest credit rating of all the states, a downgrade would leave California alone at the bottom. (Most states are rated AA or AAA.)

S&P said its rating cut on the short-term notes, and its warning on the bond rating, ‘reflect our opinion of recent state cash projections that expect significant deterioration in California’s cash position.’

The state’s budget deficit now is expected to reach $14.8 billion in the current fiscal year if the Legislature fails to cut spending, raise revenue, or both.

And as my colleague Jordan Rau reports here, the budget gap could balloon to a stunning $42 billion by July 2010.

S&P, however, is focused on the near horizon. ‘Should the state not enact timely mid-year budget gap closing measures by February 2009, or should the state’s cash position weaken significantly compared with recently revised state cash flow projections, the long-term [debt] ratings could be lowered,’ S&P said.

That could drive more investors away from California bonds, forcing the state to pay higher interest rates to borrow. As I noted in this post on Wednesday, municipal bond yields in California and elsewhere have been surging in recent weeks as investors focus on deepening state budget troubles.

As for borrowing short-term to plug budget gaps -- a California specialty -- S&P warned that without ‘meaningful budget adjustments on the revenue or expenditure side, the state may face constrained investor appetite for additional note purchases.’

Demand wasn’t a problem for the $5 billion in short-term notes California sold in October, but the state paid dearly for that money.

-- Tom Petruno