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Wall Street will have a big say on California bonds

January 11, 2007|Tom Petruno | Times Staff Writer

Even if California voters go along with Gov. Arnold Schwarzenegger's proposal for a new wave of bond borrowing for public works projects, the fate of the program -- and its cost -- ultimately would rest with the investors on Wall Street and elsewhere who buy the state's IOUs.

Here's a look at some of the issues investors will consider:

How much borrowing has the governor proposed, and what does the state owe now?

Schwarzenegger wants to sell $43 billion in bonds to finance schools, water projects and other improvements. Voters would be asked to approve the bulk of the bonds in measures on the 2008 and 2010 ballots.

The state's bond debt currently is about $55 billion. On top of that, $68 billion of bonds have been authorized by voters but not yet issued, including $43 billion just approved in November.

So even before Schwarzenegger's new proposal, "California's debt has ramped up pretty quickly in the last few years," said Robert Kurtter, an analyst at credit-rating firm Moody's Investors Service in New York.

Can the state afford to go deeper into debt?

By many measures, the state's current debt level is considered moderate relative to other states. Debt per capita, for example, was $1,473 in fiscal 2005, ranking California 13th of the 50 states, according to credit-rating firm Standard & Poor's. That was well below the levels of several big Eastern states, including New York ($2,084) and Massachusetts ($2,508).

As with a family or business, the level of debt a state can afford depends on a number of variables, including future income. If California's economy grows at a healthy pace over the next decade, the state's ability to handle more debt should increase. And Wall Street generally applauds the use of bonds to finance long-lasting capital improvements, because those should make the state a more competitive economy.

But wouldn't a bigger debt load eat up a bigger share of the state budget?

That's the key concern the credit-rating firms, and bond investors, have with rising debt.

Under the governor's plan, "debt service" -- interest and principal payments on infrastructure bond debt -- would consume more than 6% of general fund revenue beginning in 2010, compared with 4.3% this year. (Those figures exclude the hefty payments California must make to retire $11 billion in bonds sold in 2004 to close the state's then-massive budget deficit.)

Several states, including Connecticut and New Jersey, have debt service levels that exceed 6%, so California wouldn't be breaking new ground.

Still, going above the 6% threshold would at least flash a caution light, analysts say. If the economy were to sour, state tax revenue could fall off sharply. "The question may become, what do you push aside [in the budget] to make room for debt service?" said David Hitchcock, a Standard & Poor's analyst in New York.

Because of California's severe budget woes a few years ago, the state's credit rating remains depressed. Only Louisiana has a lower grade than California.

Could investors simply refuse to buy new California bonds if they feared the state was borrowing excessively?

It's highly unlikely that the largest U.S. state would find itself unable to borrow money, experts say. More likely is that, if investors became concerned about California's financial health, the state would have to pay higher-than-expected interest rates to sell new bonds.

Higher debt costs could mean that fewer projects would be financed. That would be investors' way of telling California to cut back on its building ambitions.

For now, individual and institutional investors are hungry for California's bonds. The great appeal of state and municipal IOUs is that interest paid is exempt from federal income tax. Also, most states don't tax interest paid on their own bonds.

In a world of relatively low interest rates, the double tax exemption makes California bonds attractive investments, particularly to well-heeled Californians in high tax brackets. In a sense, the state has a huge captive audience for its debt.

"You have a real strong economy with a lot of people who have a lot of money," said Robert Pariseau, manager of the USAA California Bond mutual fund.


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