UPDATE 2-IOUs shore up Calif's cash, draw investor interest
(Recasts, adds background, comments, byline)
By Jim Christie
SAN FRANCISCO, July 10 (Reuters) - California has enough cash to pay its top bills, including payments to bondholders, through September thanks to IOUs it has been issuing, but it may not be able to make payments in October due to the state's budget crisis, the state controller's office said on Friday.
And as the state struggles with its finances, holders of the IOUs face their own potential problems as three of the biggest banks in California remained on track to stop accepting the notes promising payment later on Friday.
The move by the three banks could open the door to trade the notes in a secondary market to emerge as early as Monday, spurred by any IOU holders in need of immediate cash and indications that there is a ready pool of buyers.
California last week began issuing IOUs in lieu of payments to taxpayers owed refunds and to vendors to manage its cash amid declining revenues and the impasse between Governor Arnold Schwarzenegger and lawmakers over balancing the state's books, which requires closing a $26.3 billion deficit.
The IOUs are intended to free the state's cash, sharply reduced by the recession, for priority payments. General obligation debt payments are constitutionally protected and are California's second highest priority payment behind education.
State Controller John Chiang plans to issue more than $3 billion of the IOUs this month, which will bolster the state's cash account next month. But Chiang's office said California faces a cash in October unless its budget is balanced, and that threatens it ability make its priority payments.
"Without IOUs, the state would have run out of cash and begun missing those protected payments at the end of July," the controller's statement said.
"While updated cash projections show that IOUs will preserve enough cash to make those protected payments through September, the cash shortfall in October will endanger the state's ability to make those payments," the statement said.
Schwarzenegger, huddling with top lawmakers in budget talks as Chiang's office released the statement, is intent on honoring debt payments, spokesman H.D. Palmer said.
"Going back to the Great Depression, the state of California has never missed a scheduled payment to a bondholder or noteholder and we will move heaven and earth to make sure we don't break that streak," said Palmer.
SECONDARY MARKET READIED
The U.S. Securities and Exchange Commission said on Thursday that IOUs are "securities" under U.S. law and their holders and potential buyers are protected by anti-fraud law.
The determination clarifies the IOUs' status for recipients and for entrepreneurs aiming to establish a secondary market for the notes promising payment. The notes carry a 3.75 percent interest rate and are payable on Oct. 2.
Trading the IOUs may be around the corner because options to cash them in will soon narrow. Credit unions and community banks may accept them indefinitely, but Bank of America Corp (BAC.N), Wells Fargo & Co (WFC.N) and JPMorgan Chase & Co (JPM.N) have said they will not accept them after Friday.
That may spur many recipients to put their IOUs up for sale, said Mark Murphy, a spokesman for SecondMarket Inc, a five-year-old New York-based marketplace for illiquid assets, including private company stock.
"They may not be able to make payroll and wait until October, or may need to make a mortgage payment," Murphy said of why some IOU holders may put their notes up for sale now. "If they really need cash they'll be looking into how to get that liquidity as quickly as possible."
In anticipation, SecondMarket plans to open its marketplace to IOU holders perhaps as soon as Monday, Murphy said, noting the company has been fielding telephone calls and e-mails from hedge funds, distressed-debt buyers and municipal bond investors interested in the IOUs.
"It's a feasible market but we haven't got price information yet," Murphy said.
The Municipal Securities Rulemaking Board, which writes the rules for broker-dealer conduct in the $2.6 trillion municipal bond market, on Friday reminded those who would buy and trade the IOUs that they must follow broker-dealer regulations.
General Counsel Ernesto Lanza said in a statement the MSRB is "particularly concerned" potential buyers would offer prices below fair market value to "citizens who may be in need of immediate cash." (Additional reporting by Lisa Lambert in Washington; Editing by Leslie Adler)
