LOS ANGELES -- California's $5 billion short-term annual note issue, scheduled for pricing this week, will mature earlier than usual because of concerns about a potential budget deficit of at least $2 billion later this fiscal year.
The bulk of the state's revenue anticipation notes will mature in April and May, with a smaller portion due in January. They traditionally mature in late June, just prior to the start of California's fiscal year on July 1.
Treasurer Kathleen Brown of California said the state developed the "conservative" maturity structure so the notes are redeemed before lawmakers become embroiled in trying to bridge a budget deficit already projected for next spring.
A cash pinch last June forced California to sell reimbursement warrants to help redeem its fiscal 1992 Ran.
"The possibility that the state again will face cash shortages by spring requires maturity dates that ... ensure that California will fulfill its obligations to investors," Ms. Brown said in a statement.
But the state's budget problems remain an obvious concern. Moody's Investors Service, for example, cited potential cash-flow risks to justify assigning a lower rating to notes that mature later in fiscal 1993.
Traders predicated a strong showing for the large offering -- the largest note issue in municipal history -- despite uncertainty over budget projections and competition from numerous other tax-exempt note issues. Yield estimates on the May maturities ranged from 3.10% to 3.20%, according to traders late last week. However, several market players argued that, due to the size of the offering and fluctuating market prices, yields could go even higher.
"Right now, that's pretty attractive for something this short-term," especially for a credit such as California, said Peter Auzers, vice president and manager of the western regional bond desk for Fidelity Capital Markets.
A flood of short-term notes in the market, including recent sales by Pennsylvania, New Jersey, and Colorado, helped push tax-exempt note yields higher than yields on taxable securities such as U.S. Treasury bills, which rallied last Thursday and Friday.
California's notes are "coming ludicrously cheap, and I'm sure they'll get them done," said Joseph P. Deane, a portfolio manager at Shearson Lehman Brothers for five tax-exempt bond funds, including a California fund, that total $2.5 billion. "But the bigger question is, ~What are the impacts of their budget? Is it balanced or is it a mirage?,'"
Others are asking that question as well, and their concern has played a role in prompting Moody's to assign a lower rating to fixed-rate notes maturing in April and May.
"Concerns about economic assumptions underlying the state's cash-flow projections and the probable need for a downward revision in the state's revenue forecast introduce uncertainty about expected margins of protection for the later maturities," Moody's said.
Accordingly, Moody's has assigned a MIG-2 rating to the fixed-rate noted due in April and May. By contrast, "substantial borrowable resources" earlier in the fiscal year provide more comfort for investors, Moody's said, so it has assigned a MIG-1 rating to $500 million of notes maturing in January.
Standard & Poor's Corp. has assigned an SP-1 rating to the $4 billion fixed-rate portion of the Ran, down from last year when the notes initially earned the highest rating of SP-1-plus.
Standard & Poor's noted in a statement that "cash-flow projections have been volatile in recent years and will be a challenge again in fiscal 1993."
Late Friday, Fitch Investors Service rated the fixed-rate notes maturing in January and April an F-1-plus. The May maturity received an F-1 rating.
The variable rate notes received an F-1-plus/F-1-plus from Fitch.
In addition, Fitch lowered its rating on California general obligation bonds to AA from AA-plus, because the credit trend for the state is "now uncertain."
In its May budget revision, the state Department of Finance assumed that economic conditions in California would improve in the second half of 1992. But tax revenues are already less than expected, and Ms. Brown and some economists have said the state's economy probably has not bottomed out yet.
Due to the cash-flow uncertainty and California's economic condition, the note offering's preliminary official statement includes strict new disclosure language that "there can be no assurance that [budget] estimates will be achieved and they should not be construed as statements of fact."
Hal Geiogue, assistant state treasurer, said he and other officials "went out of our way" to include language that would "stress the uncertainty of the numbers."
Gilbert T. Ray, a partner at O'Melveny & Myers, the underwriter's counsel, acknowledged, "There has been some deterioration in the numbers since May. We felt it was important to allude to that in disclosure language."
Several traders noted that California lacks much of a cushion if things get worse. The new budget provides only $28 million for the economic uncertainties emergency fund, down from levels exceeding $1 billion in recent budget years.
This year's note issue, like last year's $4.1 billion sale, includes both fixed-rate and variable-rate securities. An estimated $4 billion will be fixed-rate notes and $1 billion will be variable-rate.
The state expects to have $500 million of fixed-rate notes mature on Jan. 13 and $2.5 billion of fixed-rate rates mature on May 12. The $2 billion balance, a mix of fixed-rate and variable-rate notes, will mature April 26.
Ratings for the variable-rate portion hinged on pending analysis of the bank standby purchase agreement, rating agency officials said.
Lehman Brothers is the book runner and co-senior manager on the note issue, with Goldman, Sachs & Co. and Merrill Lynch & Co. as co-managers.
Claire G. Cohen, executive managing director of Fitch Investors Service Inc., said there is continuing concern about California's long-term economic prospects because "recession has taken a different path in California than expected. It's viewed now as a more long-term problem."
Ms. Cohen added that the early maturity dates for the notes are a "good insulating feature" because they will be redeemed before a potential cash crunch develops. "If the noteholder is out of it by May, then they don't get caught up in the budget," said Ms. Cohen. "It puts the yearned problems on California internally."
Mr. Geiogue agreed with that notion. By moving up the note maturities, California is trying to "shift any risk to the state and away from investors," he said. "We don't want the risk on the buyers' backs."
Richard Larkin, managing director of state ratings at Standard & Poor's, said the early maturity provides "some comfort," but he also cautioned that the state's cash-flow positions could erode by early next year.
"I wouldn't rule out the possibility that as things deteriorate, they would have to do more notes," as the state did last fiscal year, he said.
Mr. Geiogue said the state could sell reimbursement warrants to make note payments if it lacked cash to redeem them.
"We've got some experience, and we know there is some risk out there," Mr. Geiogue said. "If we get into trouble, we can sell another reimbursement warrant."
