LOS ANGELES -- Ratings on 13 issues of California lease revenue bonds could be downgraded because of concerns over missed payments if the state's budget impasse continues into September, state Treasurer Kathleen Brown said yesterday.
Unless a budget or urgency legislation is approved by midnight Aug. 31, Ms. Brown said she will be forced to tap reserve funds to pay $109 million of debt service due Sept. 1.
Rating agencies have indicated in conversations with the state "that payment of the debt service from reserves would constitute a technical default in their eyes and trigger another downgrade." Ms. Brown said in a statement.
"I fear not only the additional costs such a downgrade would cause, but also the continuing loss in confidence it would create among investors in California."
Figures were not available yesterday on the principal amount of lease revenue bonds that might be affected by the missed payments. Moody's Investors Service said the state has about $2.88 billion of lease revenue bonds outstanding.
Officials at the rating agency said they view the prospect of the state defaulting on lease payments due on the 13 issues Sept. 1 as a serious development.
A Moody's statement expected today will "make the point that prompt action is needed" to avoid serious consequences for the state's lease ratings, said George Leung, manager of state ratings for the agency.
Steve Zimmermann, a managing director of Standard & Poor's Corp., said analysts are monitoring the budget process and any attempts at urgency legislation that would pave the way for scheduled debt service payments.
"They have a lot of irons in the fire and we are watching the situation closely," Mr. Zimmermann said yesterday, adding that the lease revenue bonds could possibly be placed on CreditWatch this week. The debt then could be downgraded or removed from CreditWatch, depending on how the state addresses the situation.
Unlike debt service on general obligation bonds, which receives priority for payment under the state constitution, payments on lease revenue bonds depend on an appropriation included in a budget. Accordingly, California can only make payments on lease revenue debt service due Sept. 1 if a budget is adopted by Aug. 31. The state also is studying urgency legislation that would let it make the payments.
Lease revenue bonds in California have funded various capital projects, such as prisons and higher education facilities.
The state may already be in "technical default" on some of its leases, according to William Madison, a lawyer at Jones, Hall, Hill & White. Standard lease contracts that have been used by the state often contain clauses requiring the state to budget and appropriate lease payments each year, and these clauses define noncompliance with such covenants as "technical defaults," he said.
"What a black eye for the state" if it missed those payments, he said. The treasurer's warning about the lease default is "starting to bring home that the longer this [budget impasse] goes on, the more serious the consequences are going to be," he added.
Moody's on July 6 downgraded the majority of California's lease revenue bonds to A1 from Aa, as well as dropping ratings on the state's general obligation debt. Standard & Poor's downgraded California's lease obligations on July 15, with some ratings falling as low as BBB-plus-provisional, as part of a downgrade of California's GO debt.
Ms. Brown said another downgrade would hamper efforts to market future lease revenue bonds for prisons, state buildings, and higher educational facilities and "still get a good deal for the taxpayers."
She called on Gov. Pete Wilson and the state Legislature to "enact a credible budget immediately" to prevent another downgrade.
State leaders have been unable to agree on ways to bridge the state's $11 billion budget gap since the start of California's fiscal year on July 1.
The state's longest budget impasse in history has dragged into this week, after Gov. Pete Wilson vetoed an education financing bill on Sunday. Lawmakers had reached a compromise last week on funding policies for local governments, signaling the first major progress in the long stalemate. However, state officials warned Sunday that the veto could mean that the impasse will continue into September.
Bernie Schroer, senior portfolio manager for the Franklin Group of Funds, estimated that 2% of the firm's portfolio includes California state lease revenue bonds. But he noted that even if ratings fell to non-investment grades, his firm would not sell the securities.
"We wouldn't panic and sell them. We might not be a buyer, but we wouldn't sell," he said. "We don't think the state will renege on their obligation for the leases."
Mr. Schroer said the long budget impasse could be positive for the state if lawmakers make some significant spending cuts.
"If it takes until November for it to be done the correct way, so be it," he said. "Take as long as you want but get it right."
He added that "we're still very positive on the state of California."
