California retains Aa from Moody's; Fitch also affirms AA rating on GOs.

LOS ANGELES -- Moody's Investors Service yesterday confirmed its Aa rating on California's general obligation bonds, and assigned the highest rating possible to the state's $2 billion revenue anticipation note sale planned next week.

Late yesterday, Fitch Investors Service also affirmed its AA rating on the $17.6 billion of GOs, with an "uncertain" credit trend.

The long-term rating confirmation reflects the state's continuing efforts to achieve budget stability, including three straight years of "dramatically restrained expenditure growth," Moody's said in a release.

"More fundamentally, the Aa rating encompasses the depth and diversity of the state's economy and its moderate debt levels."

Market participants in recent days have eagerly awaited the rating agencies' reaction to the state's latest budget agreement, which was passed on time for the fiscal year that began July 1.

Standard & Poor's Corp. rates California GOs A-plus. Officials at Standard & Poor's and Fitch said they expect to rate the notes by either today or Monday.

"Recent economic data indicate that the economy is beginning to stabilize and, while strong revenue growth cannot be expected, the actual declines in revenue experienced over the last two years are unlikely to persist," Moody's said.

Moody's said the state's strategy toward funding its accumulated deficit also has improved, though the approach "remains vulnerable to the economy and next year's budget policies." Fiscal pressure will persist for at least the next two years, Moody's added.

Fitch said, "The major challenge to the state is to keep expenditures within the [budget] plan to enable sufficient operating surplus for deficit retirement."

The accumulated deficit remains at $2.8 billion, essentially the same level as a year ago, Moody's noted. In response, the state has now decided to fund the accumulated deficit over two budget years, a plan that "remains ambitious," Moody's said.

"Nevertheless, the new deficit funding strategy represents a more deliberate and controlled form of deficit funding and recognizes the need to focus on the ability to balance the budget over a multi-year period," Moody's said.

The rating agency said it based its MIG-1 note rating on various factors, including the fact that "timely note repayment is assured by satisfactory projected cash balances from available resources."

Moody's also said the state has demonstrated its ability to retain access to the short-term markets under stressful conditions.

Moody's also commented on the state's decision to transfer $2.6 billion of local property taxes to schools from other local governments.

"From the narrow focus of state budget balance, the $2.6 billion property tax shift has an obvious, substantial, and positive effect on the state budget," Moody's said.

However, Moody's also noted that reductions in the level of local public services "can be expected, and these will have a negative impact on the state's business climate and quality of life."

Moody's said "the severity of the economic damage from these factors is unpredictable." Based on past experience in other states where localities faced fiscal distress, Moody's predicted the local funding pinch in California "will continue to pose potential budget and economic pressure at the state level."

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