Two out of three major bond-rating firms now agree: California is a B-grade credit -- and maybe worse.
Moody's Investors Service on Tuesday cut the state's debt rating two notches, to Baa1 from A2, warning that the risk was rising that California could have trouble paying its bondholders if the budget stalemate in Sacramento didn't end soon.
The firm said the state remained on its "watchlist" for further downgrades.
Moody's Baa1 rating is just three notches above the level at which California's $59 billion in general obligation bonds would be considered "junk," or no longer investment-grade in quality. Next would be Baa2, then Baa3, then the junk rating of Ba.
The state has never had a junk rating before, and some Wall Street analysts doubt that the rating firms would cut California that low, short of a deeper crisis that would seriously threaten the state's ability to make bond payments.
State Treasurer Bill Lockyer has insisted that California would never default on its bond debt.
The state Constitution mandates debt payments, which must come before all other state spending except funding for education.
Lockyer's spokesman, Tom Dresslar, said the state would continue to manage its cash to assure that there was sufficient money to make bond payments.
The state this month began issuing IOUs to pay vendors and other so-called non-priority creditors. The decision to use IOUs was partly spurred by the need to retain cash for bond payments.
Moody's rival Fitch Ratings on July 6 cut its rating on the state's debt to BBB from A-minus. Standard & Poor's, the other member of the Big Three, still has California at A.
Most states are rated AAA or AA.
Moody's said its latest downgrade "reflects the increased risk to the legally or constitutionally required payments ('priority payments') as the state deadlock continues.
"Moody's believes that as the days and weeks go by without enacted solutions to the current cash crisis and the $26-billion budget gap, the risk to priority payments, and eventually debt service payments, is increasing."
The firm said that a continued delay in balancing the budget "could result in a further downgrade in coming months."
What's more, Moody's indicated that a budget resolution wouldn't necessarily mean a rating upgrade from current low levels. That would depend on whether the steps taken "provide long-term solutions or quick fixes," the firm said.