By Jim Christie
SAN FRANCISCO, July 7 (Reuters) - California "IOU" recipients can turn to credit unions and check-cashing storefronts if a state budget deal does not appear by Friday and if three major banks refuse to accepting the notes beyond Friday as planned, analysts said on Tuesday.
The willingness of the smaller institutions to take IOUs from the cash-strapped state should also stop the development of a secondary market for trading them, although individuals could end up paying hefty fees to get their hands on cash.
The state government of California, the world's eighth largest economy, is experiencing a severe revenue slump brought on by recession, rising unemployment and the lengthy housing downturn, forcing it to issue IOUs in lieu of some payments.
The government of the most populous U.S. state began its fiscal year on July 1 with a $26.3 billion budget gap and risks burning through its cash unless Governor Arnold Schwarzenegger and lawmakers quickly balance the state's books. Most U.S. states are not permitted to run budget deficits.
Three major banks are currently accepting the IOUs, but only through Friday. After that recipients may turn to credit unions to cash them or, perhaps, to check-cashing storefronts.
Their cashiers could see more than $3 billion of the IOUs at their windows this month should the state budget crisis persist and big banks hold to their Friday cut-off for processing them.
Check-cashing storefronts are especially well poised to score IOUs, said Daniel Penrod, a senior industry analyst at the California Credit Union League.
"I could see a lot of bank customers turning to a third-party source and losing a lot of their paycheck," Penrod said.
Friday's deadline at Bank of America Corp (BAC.N), Wells Fargo & Co (WFC.N) and JPMorgan Chase & Co (JPM.N) has raised questions about what recipients, including taxpayers owed refunds and vendors to the state government, would do with IOUs received after the end of the week.
State Controller John Chiang began issuing the IOUs, technically registered warrants, last week to help the state government manage its dwindling cash to pay priority bills, including payments to investors holding the state's debt.
To help the state, the three banks said they would take the IOUs through July 10. The banks would pay the face value of the warrants and become their official holders. The warrants carry a 3.75 percent interest rate and are payable Oct. 2.
A Bank of America spokeswoman said Friday's deadline allows the bank to help clients and customers and the state's short-term needs. Friday is a "firm" deadline for Wells Fargo, a spokeswoman said, declining further comment.
A JPMorgan Chase spokesman said the company's banking operations, which include 712 Chase retail banking branches in California formerly operated by Washington Mutual, are reviewing Friday's deadline.
The three banks likely set a Friday deadline to press for a resolution to the state's budget crisis, said Beth Mills, a spokeswoman for the California Bankers Association.
"Putting a deadline on there might encourage the legislature to act," Mills said, adding that the cut-off may also have been set because processing the IOUs imposes "operations costs" offsetting their hefty interest rate.
"Banks even beyond July 10 are willing to step forward to help their customers. They just may not be willing to accept IOUs. They may extend them a line of credit or do bridge loans," Mills added.
By contrast, credit unions will accept the IOUs after Friday, which would require non-members to join local credit unions to cash the warrants, said Penrod,
Addressing speculation of a secondary market emerging for the warrants, Penrod said that would be unlikely. Even so, California Treasurer Bill Lockyer's office said on Monday it would redeem IOUs sold through eBay Inc (EBAY.O), Craigslist or other means, if accompanied by a notarized bill of sale signed by their recipient.
Some have wondered how the IOUs will be regulated in the secondary market. If they are deemed securities by the Securities and Exchange Commission, then those buying and selling them could be subject to federal law on broker-dealers. Currently, SEC officials are analyzing the issues involved.
Penrod said the banking industry will more likely face competition for California's IOU business from storefronts that cash checks for a fee. "You'd add the fee into the 3.75 percent for a less-than-one-year note, which is essentially what it is, and that's a great rate," Penrod said.
additional reporting by Lisa Lambert in Washington