California's Federally Taxable Various Purpose GO Bonds Rated 'AA-' With A Stable Outlook

NEW YORK (S&P Global Ratings) March 14, 2019--S&P Global Ratings assigned its 
'AA-' long-term rating to the State of California's $800 million federally 
taxable various purpose general obligation (GO) bonds. 

At the same time, S&P Global Ratings affirmed its 'AA-' long-term ratings and 
underlying ratings (SPURs) on California's $73.1 billion of GO bonds 
outstanding, as of Jan. 1, 2019. S&P Global Ratings also affirmed its 'A+' 
long-term ratings and SPURs on the state's $8.9 billion in 
appropriation-backed lease revenue bonds outstanding as of Jan 1. 

In addition, we affirmed the long-term component of the 'AA+/A-1' and 
'AAA/A-1+' ratings on some of the state's GO variable-rate demand bonds. The 
long-term component of the ratings is based jointly (assuming low correlation) 
on that of the obligor, California, and the various letter of credit (LOC) 
providers. The short-term component of the ratings match the ratings of the 
LOC providers. The outlook on all long-term ratings is stable.

The GO ratings are based on our view of the state's:
  • Diverse economy of 39.8 million people (estimated 2018);
  • Good budgetary reserve levels funded in part from a redirection of capital gains-related revenues;
  • Strong enough overall liquidity in fiscal 2019 that for the fourth consecutive year; and
  • Declining, but still moderately high, debt ratios.
Somewhat offsetting these strengths, in our opinion, are California's:
  • Persistently high cost of housing relative to that in other states, which poses a threat to longer-term economic growth prospects;
  • Difficult-to-forecast revenues because of a volatile revenue base correlated with financial market performance as well as a reliance on a highly progressive personal income tax structure;
  • Minimal prefunding of retiree health care benefits (other postemployment benefits, although the state has reached agreements with its labor bargaining units to phase in over several years normal cost contributions; and
  • Large backlog of deferred maintenance and infrastructure needs, though now with a source of revenue to bridge much of the annual funding gap.
The state's general fund serves as the source of all GO bond repayment, to 
which California has pledged its full faith and credit. 

The stable outlook reflects, in part, the current structural alignment of 
California's fiscal operations (with recurring revenues sufficient to fund the 
state's legally required ongoing expenditure base). Although California's 
fiscal position is much improved from five and 10 years ago, and the state's 
new governor has prudently proposed using a good portion of revenue growth for 
continued buildup of reserves and one-time expenses, we attribute the state's 
post-recession gains to a combination of cyclically favorable economic 
conditions, the previous governor's emphasis on reserve accumulation, and 
California's current (nonpermanent) tax policy. While we view the governor's 
proposed budget for fiscal 2020 favorably from a credit perspective, it 
remains to be seen whether the legislature will retain these goals in the 
final adopted budget. Recent income tax revenue declines in December and 
January compared with prior-year periods could also see downward revisions in 
forecasted revenue when the governor's May budget revisions are released. If 
structural budget alignment remains a fiscal policy priority when the fiscal 
2020 budget is enacted, we could potentially revise the outlook to positive. 

The main downside risk we see to our rating on California through our two-year 
outlook horizon is the potential for unanticipated economic and fiscal stress 
coinciding with an adopted budget that expands ongoing expenditures to the 
extent that the money to pay for them must come from cyclical or one-time 
revenue sources. This could occur if structural balance were jeopardized by a 
substantial fall in capital gains as the result of a sustained decline in 
equity markets, general economic weakening, or the withdrawal of federal 
fiscal aid. Both the severity of such a scenario and lawmakers' response to it 
(such as timely versus delayed or structural versus one-time corrective 
measures) could affect our view of the state's credit quality, particularly in 
light of constitutional requirements for a legislative supermajority in order 
to raise tax rates.
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