* 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 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
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
"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
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
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
"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.