UPDATE 2-Fitch downgrades California GO bonds to 'A'

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By Jim Christie

SAN FRANCISCO, March 19 (Reuters) - Ahead of a major bond sale next week by California, Fitch Ratings on Thursday cut its "A+" rating on $47.4 billion of state general obligation debt to "A" with a stable outlook, citing falling revenues and the weak economy in the most populous U.S. state.

Fitch analysts in a report noted California's "economic performance and revenue expectations have continued to decline since the state developed its current revenue forecast in November 2008," and pointed to a state unemployment rate of 10.1 percent and a recent state legislative analyst's warning of a "sizable" revenue shortfall in the next fiscal year.

"The driving concern is the weakness of the state's economy and the outlook for state revenues," Fitch Senior Director Douglas Offerman told Reuters.

Fitch analysts applauded the deal between Gov. Arnold Schwarzenegger and lawmakers last month to balance the state's budget and close a $42 billion deficit through July 2010, calling it a "significant and welcome achievement."

But they said the state's financial stability is uncertain because of its weakening economy, which likely will reopen the state's budget gap. Also, voters must approve budget-related ballot measures in May to help fill the state's coffers.

One measure would allow the state to sell $5 billion in debt backed by state lottery revenues. Another would impose a state spending cap and extend tax increases in last month's budget package to help raise revenues.

Fitch's downgrade follows a cut by Standard & Poor's Ratings Services last month to its rating on California general obligation debt to "A" from "A+," which left the biggest issuer of U.S. public debt with the lowest-rated general obligation bonds of any state.

The lower ratings threaten to increase California's borrowing costs, which may be substantial given its need for improving and expanding public works.

AHEAD OF MAJOR BOND SALE

California next week will sell $4 billion in general obligation debt, marking its first sale of general fund-backed bonds in the municipal market since June.

Tom Dresslar, a spokesman for state Treasurer Bill Lockyer, dismissed Fitch's downgrade and predicted it would not have a negative effect on next week's sale, which is highly anticipated in the market. Fitch assigned its "A" rating to the bonds California will sell next week.

"We're confident that regardless of how Fitch, Standard & Poor's and Moody's rate our bonds, investors are going to buy our bonds," Dresslar said.

"We've never defaulted," Dresslar added. "Investors in California bonds have never failed, not once, to get what is owed them."

Lockyer's office has been fighting a running battle with credit rating agencies, arguing they hold municipal debt issuers to higher standards than corporate issuers, resulting in higher borrowing costs for governments, which pose little default risk.