If the budget deal reached in Sacramento on Monday is more than smoke and mirrors, California should soon be able to stop issuing IOUs and turn back to Wall Street for short-term financing.
But before that can happen, state Treasurer Bill Lockyer and Controller John Chiang will have to determine how much cash will be coming in the door this fiscal year, and how much less will be going out because of budget cuts.
"At this point, it's too early to assess the effect of the budget deal on our cash borrowing needs," Lockyer said in a statement Tuesday.
"Until enactment of the budget changes by the Legislature and the governor later this week, it will not be possible for anyone to estimate or announce the size, sequence or scheduling of any short-term cash borrowing," he said. "That determination will be made in collaboration with the controller's office and the Department of Finance after we study an analysis of new state cash-flow reports."
Investors, too, will be "stress-testing the budget to determine if it's for real," said Paul Rosenstiel, former deputy treasurer under Lockyer and now a principal at municipal bond dealer De La Rosa & Co.
Wall Street's reaction will be crucial. Normally by this time of the year the state would have tried to borrow $5 billion to $10 billion via short-term revenue-anticipation notes, or RANs. That borrowing would have bridged the gulf between near-term spending needs and future tax revenue.
But Lockyer couldn't go to investors for a loan without a budget in place. Without that borrowing, and with the state running short on cash, Chiang had to begin paying many of the state's bills with IOUs this month.
Once a budget is set, the state is likely to borrow billions of dollars either via RANs that will mature before July 1 of next year or using so-called revenue-anticipation warrants, or RAWs, which might not mature until sometime in 2011.
The big question: What will the state have to pay investors? In June, when Wall Street was hoping that a budget would be sealed by July 1, some analysts were figuring the state would have to pay a tax-free annualized yield of at least 5% to attract investors to a RAN offering of as much as $10 billion.
Matt Fabian, senior analyst at research firm Municipal Market Advisors in Westport, Conn., says the 5% range may still be realistic for a RAN deal if investors are satisfied with the state's cash-flow projections through next June.
If the state opts for a longer-term RAW debt sale, "5% to 6% would be a reasonable target" for the yield, he said.
Compared with other interest rates available on short-term debt, those returns would be extraordinarily rich for investors willing to take the risk.
Consider: If California didn't have the worst financial image of any state in the Union, it would probably be paying a tax-free yield of 1% or less on a RAN borrowing.