California vote comforts muni market, at least for now
* Sweeping fiscal reforms become a possibility
* State go bonds already enjoyed investors' favor
* S&P wants to see a more steady source of revenue
By Jim Christie
SAN FRANCISCO, Nov 9 (Reuters) - Investors holding cash-strapped California's bonds could be among the big winners of Tuesday's elections.
Voters approved Governor Jerry Brown's tax measure to help keep the state's budget balanced and gave his fellow Democrats a super-majority of seats in the legislature, which at least in theory may help the passage of sweeping fiscal reforms.
Prices have already reacted. The 30-year differential yield between California general obligation bonds and Municipal Market Data's benchmark triple-A scale fell to 74 basis points on Thursday from 78 on Monday.
Demand for California's debt could rise even further, but some analysts and rating agencies suggested caution.
With the Democrats controlling for the first time in nearly 80 years two third of the votes, more taxes can be more easily approved, provide a steady source of revenue and entice even more investors to buy the state's bonds.
"It's got to lend some stability to the way people feel about our state's paper," said Kelly Wine, executive vice president at muni broker-dealer RH Investment Corp in Los Angeles.
Rick Ashburn, chief investment officer of Creekside Partners in Lafayette, California agreed: "Democrats are now in charge and they can do whatever they need to do to fix the budget."
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Standard and Poor's said that lawmakers will need to keep a lid on expenses to help the state earn an upgrade to its low credit rating.
"There is potential, in our view, for material improvement of the state's credit quality if lawmakers reach agreement on reforms that help stabilize the state's fiscal performance while the temporary taxes are in effect," Standard & Poor's said in a report.
Brown's tax measure raises the state sales tax by a quarter-cent for four years and increases income tax rates for seven years for individuals earning more than $250,000 a year.
California's top personal income tax rate was already the second highest in the nation at 10.3 percent before Tuesday's vote, and will now rise to 13.3 percent to help raise an estimated $6.5 billion to $7.5 billion a year.
California, whose economy is one of the 10 largest in the world, has struggled with weak revenue for several years due to the housing market crash, financial market turmoil and the recession. The state's leaders have slashed spending and this year began to grapple with long-term financial challenges, like those posed by pensions expenses.
Critics say a recent overhaul of pension spending was watered down and more dramatic changes to curb retirement-related spending are needed.
Over the last year California bonds have rallied as investors gained confidence in its debt, while three municipal bankruptcies cast a cloud over the debt of the state's local governments.
Spreads between the yield on California's 30-year general obligation bonds and MMD's triple-A benchmark tightened by 56 basis points over the past year. The equivalent spread for debt issued by struggling Illinois narrowed by 36 basis points over the same period.
S&P rates California the lowest of all states, at A-minus, and downgraded Illinois to A in August. Moody's Investors Service rates Illinois just below California.
Marilyn Cohen of the Envision Capital Management fears lawmakers may interpret tax increases as a mandate to ramp up spending instead of strengthening the state's long-term finances.
"It's credit positive in the short term but they're not going to change their ways in the long term. All they know is how to spend more than they take in," Cohen said.
Brown has promoted budget discipline since his election in 2010 and has had to push Democratic lawmakers into spending cuts and an overhaul of public pensions.
In the short run, tax increases mean $6 billion in planned near-term spending cuts are off the table to the relief of school districts, which would have felt the brunt of the cuts.
"From the narrow perspective of school district debt, this is a credit positive since school district revenue cuts would have generated financial strains for many school districts in the state," a Janney Capital Markets report said.
Moody's has a more cautious view for the districts. "Regardless of future revenue growth, the most significant financial credit factor remains each district's management ability, particularly during these periods of fiscal uncertainty," the rating agency said in a report on Friday.
With voters approving the tax measure, spreads on California school district debt should tighten as concerns about them losing state funds ease, said MMD analyst Domenic Vonella.
Long Beach (California) Unified School District general obligation bonds due in 2030 and rated Aa2 by Moody's and AA-minus by S&P traded on Friday at 2.72 percent yield, 53 basis points above the MMD triple-A yield for 2030 maturities. On September 25, the bonds traded with a yield of 2.98 pct, 59 basis points above the MMD triple-A yield for 2030 maturities.
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