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Wall Street awaits California's short-term borrowing plans

The state's budget crisis is likely to make financing to bridge the gap between current cash needs and future tax revenue more complicated and expensive.

July 03, 2009|Tom Petruno

Wall Street is looking forward to learning California's short-term borrowing plans -- once Sacramento produces a fiscal 2010 budget more or less in balance.

The bond market has been expecting that the state would seek short-term financing to bridge the gap between current cash needs and future tax revenue.

Normally, this kind of borrowing -- via so-called revenue anticipation notes, or RANs -- is no big deal. Investors usually are eager to fund the notes because they mature in 12 months or less, and the interest paid is exempt from state and federal income tax.

But Treasurer Bill Lockyer signaled Wednesday that he doesn't believe the state will be able to move ahead with normal RAN financing this month, even with a budget deal. He thinks the magnitude of California's fiscal trouble means investors couldn't be assured of repayment within the current fiscal year (by June 30, 2010), as required with RAN debt.

"Given the fact that the budget hole got deeper, this is not a RAN year," Lockyer said in an interview.

Wall Street has been expecting the sale of as much as $10 billion in one-year RANs by Lockyer's office at a high tax-free interest rate -- perhaps 5% or so, which would be a lucrative return for investors on such short-term debt.

Instead, the state will have to raise cash via revenue anticipation warrants, Lockyer said. Warrants, which would be issued by state Controller John Chiang's office, would allow the state to borrow for a longer period, perhaps two years or so in this case. (These warrants would be separate from the IOUs, also called warrants, that Chiang began issuing Thursday as payment for state operating expenses.)

Gov. Arnold Schwarzenegger last month revoked the state's ability to issue revenue anticipation warrants without having a balanced budget in place. But assuming a budget deal is reached, Schwarzenegger could quickly reinstate that ability. He would have to do so, because the state will almost certainly have to do some kind of short-term borrowing to manage its cash flows.

Matt Fabian, senior analyst at research firm Municipal Market Advisors in Westport, Conn., estimated that the state would have to pay annualized tax-free yields "north of 5%" on warrants as a penalty for its poor credit rating.

A sale of either RANs or warrants would test investors' willingness to extend credit to California since the state's budget nightmare has worsened over the last two months.

Despite the state's tattered financial image, many players in the municipal bond market had expected individual and institutional investors to step up for a RAN deal because of the anticipated interest rate. A RAN offering last October was wildly popular with individual investors. Warrants, however, could be a tougher sale because of their longer terms.

If the state is willing to pay an annualized yield of, say, 5.5% to get a warrant deal done, that would far exceed rates available to investors on other short-term debt. At that price, many yield-hungry investors might not be able to resist California, warts and all.

Consider: Los Angeles County paid just 0.8% to issue $1.3 billion in one-year tax-free notes June 10. One-year U.S. Treasury bills currently pay an annualized yield of about 0.5%.

Investors' gain, of course, would be California taxpayers' pain: That high interest cost would further sap the state budget. Lockyer in May sought a federal guarantee on the state's short-term borrowings to assure a lower interest rate, but the Obama administration turned him down.

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tom.petruno@latimes.com

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