Firms Lower Ratings of State's Long-Term Bonds : Finances: Wall Street credit watchers react to wobbly budget. As a result, California will pay higher interest.

By MARK GLADSTONE

July 16, 1994 12 AM PT

TIMES STAFF WRITER

SACRAMENTO — Citing the state’s wobbly financial condition, the big three Wall Street credit-rating firms Friday downgraded their opinion of California’s long-term bonds, marking a fall in just three years from the top of the ratings ladder to a spot near the bottom.

The action means that in the future, California will be forced to pay more in interest to issue new long-term bonds to compensate investors for the higher risk. But exactly how much more interest the state will have to pay is a matter of debate.

Since 1991, when California enjoyed a coveted AAA rating, the state has seen its grade lowered three times by all three ratings firms.

Standard & Poor’s reduced its rating on California bonds from A+ to A, one step from the cellar occupied by New York in the company’s rating chart. Moody’s Investor Service dropped the bonds from Aa to A1 and Fitch Investors Service revised its rating from AA to A. The states with the highest bond ratings--such as Utah, Virginia and Maryland--generally have balanced budget plans set on time and do not rely on overly optimistic revenue projections.

The last time all three firms lowered their rating of the state’s bonds was in 1992 during the 63-day budget crisis that forced the state to pay its bills with IOUs. The ratings affect the sale of the state’s long-term general obligation bonds, usually sold in 20- or 30-year increments and used to finance the construction of schools, prisons, water systems and other projects. California sells about $3 billion of such bonds each year.

The news from New York was disappointing to Republican Gov. Pete Wilson, whose reelection is being challenged by Democratic Treasurer Kathleen Brown. Indeed, even as the downgradings were being disclosed, Brown was holding a telephonic news conference to blame the governor for the bad report from Wall Street.

In response, state Finance Director Russell Gould downplayed the significance of the announcements and complained that Brown, with whom he visited Wall Street this week, had “undermined efforts to obtain the best credit rating for California.”

Still, Gould conceded that the news was disappointing for Wilson, who last week signed a $57.3-billion state budget that depends on a highly unlikely $2.8-billion federal bailout, at least $4 billion in borrowing, and a standby measure that could trigger automatic across-the-board reductions in all state programs except education.

All three provisions were singled out by the rating agencies as among the reasons to lower the state’s bond rating.

In making its announcement, Standard & Poor’s cited the budget’s “reliance upon a blunt trigger mechanism to reduce spending” and said “these potentially Draconian automatic cuts could disrupt state operations, particularly in fiscal 1996.”

S & P and the other two rating services also cited the budget’s dependence on a “questionable” federal bailout to pay for the cost of illegal immigrants as well as restrictions imposed by Proposition 98, the voter-approved measure that guarantees a minimum proportion of state revenues for kindergarten through community colleges, and the persistent budget deficit that requires heavy borrowing.

“Despite an improving economy, the state has been unable to enact a realistic plan to fund the accumulated deficit” without heavy borrowing, Moody’s announcement said. Indeed, the state had to pay Bank of America and a consortium of international lenders $30 million just to co-sign a record $4 billion loan to keep the state afloat.

Steven Zimmerman, a San Francisco-based executive in S & P’s municipal finance department, said his firm had foreshadowed Friday’s announcement in February by issuing a negative outlook for California. He said his company decided to drop the ratings because the state’s financial situation “had deteriorated.”

Zimmerman said that although the lowering means that California is a riskier borrower, S & P still anticipates that the state will pay off its debts and not default.

Brown said the decision by credit rating agencies should not affect billions of dollars in short-term debt the state is borrowing next week. In fact, Zimmerman noted that the short-term notes backed by the consortium of banks were given a top rating by S & P.

Brown said the ratings announcement made Friday a “grim day for the Golden State” and for taxpayers, noting that California’s rating is now among the nation’s worst.

She contended that the downgrading “is directly tied to the state’s budget and the failure of the governor to present a credible plan to pay off the accumulated deficit.”

Finance Director Gould said Brown’s criticism of the Wilson Administration has not “been helpful in terms of sustaining our rating and I think that’s unfortunate.”

Gould said he could not immediately estimate the cost to taxpayers of the lowered rating and maintained that the state’s economy is rebounding with “very positive signs.” But Brown’s office said the lower rating would cost the state roughly $1 million a year for each $1 billion borrowed.

The treasurer’s office says general obligation bonds issued since the first downgradings in 1991 will cost the state an extra $529 million over the lifetime of the bonds.

Reacting to Wall Street criticism, Gould said it is unlikely that the automatic cuts in the budget will be triggered and that the mechanism reflects fiscal discipline by Wilson and the Legislature. Moreover, he backed Wilson’s efforts to obtain reimbursement from the federal government for services rendered to illegal immigrants.

But Democratic Controller Gray Davis said Friday’s actions show that Wall Street is skeptical that Washington will bail out California.

“California is making a massive bet on the (outcome)--Wall Street is saying it is a bad bet,” Davis said in a statement.

“The governor’s reliance on $3.5 billion in federal money has forced us to go to extra lengths to shore up our short-term borrowing. The ratings agencies are saying short-term investors should have no fear, but the state has long-term problems that must be corrected.”

Times staff writer Virginia Ellis contributed to this story.