Fitch Rates California $720MM GOs 'A'

Business Wire, April 7, 2006

NEW YORK -- Fitch Ratings assigns an 'A' rating to the State of California $300 million various purpose general obligation (GO) bonds and $420 million GO refunding bonds, which will sell competitively on April 12. Fitch also affirms the 'A' rating on approximately $36.4 billion State of California outstanding GO bonds. The 'A' rating assigned to $1.3 billion veterans GO bonds and the A rating assigned to $9.94 billion GO economic recovery notes also are affirmed.

The strength and growth of the California economy, coupled with the strong revenue recovery from the steep declines earlier in the decade, continue to propel California toward financial recovery. Revenue estimates have been raised, primarily due to strength in personal and corporate income taxes, leading to sizable year-end balance estimates. The structural budget imbalance continues to slowly shrink. However, with pent-up demand, spending growth in the proposed fiscal 2007 budget exceeds projected revenue growth and substantially absorbs the surplus. Revenue estimates appear conservative, although the reduced fund balance cushion would leave the state vulnerable to unforeseen events, such as potential capital gains and real estate volatility. Debt ratios are moderate, providing capacity as the state considers funding large capital needs.

California's broad economy continues to experience moderate growth in all regions, including northern California, which experienced the greatest decline during the recession. Employment growth has overtaken the U.S. rate of growth, with state employment rising 1% in 2004 and 1.8% in 2005, compared to 1.1% and 1.5% nationally. February data suggests the trend continues, with employment up 2%, compared to 1.6% nationally. Notably, construction employment leads all sectors with a 7.1% increase. State personal income grew 6.6% in 2004 and 6.0% in 2005 compared to 5.6% growth for the U.S. in 2005. The budget reasonably projects slight slowing in 2006, with employment and personal income increasing 1.3% and 5.8%, respectively. Residential real estate is now cooling, with housing sales and permits down in the latter half of 2005 and the growth in home prices decelerating. The budget assumes a moderate correction; a steep decline would have a broader economic and revenue impact.

Major tax revenues dropped $13 billion in fiscal 2002, primarily from reduced personal income taxes from capital gains and stock option losses. Spending was not correspondingly reduced, leading to deficits and a cash flow crisis relieved through one-time measures, internal and external borrowing, and, ultimately, the issuance of deficit bonds. Improvement has occurred, primarily through annual revenue growth of about 7% in each of the last two fiscal years including the current one. The fiscal 2007 budget, proposed in January, included a $5.5 billion upward revenue revision covering the two fiscal years, compared to those estimates contained in the adopted fiscal 2006 budget, reflecting higher personal and corporate income taxes. Capital gains and stock options, which plummeted from nearly 25% of general fund revenues prior to the downturn to 7%, are estimated to have climbed to approximately 13% of general fund revenues in fiscal 2006. Gains from real estate transactions are estimated to constitute a significant component.

The 2007 proposed budget reasonably projects revenues to increase 4.4% to $91.5 billion; however, spending grows by 8.4% to $97.9 billion resulting in a $6.4 billion operating loss that reduces the fund balance to $674 million. The $6.4 billion operating deficit compares to $7.5 billion projected at the time the fiscal 2006 budget was adopted and reduces to $4.7 billion if prepayments of loans and early payment of the deficit bonds and other obligations that are included in the budget proposal are excluded. Spending growth is fueled by education, increasing by approximately 10.5%, while transportation and Medicaid also receive significant increases. Major taxes increase 5.7% compared to 6.2% estimated in the current year.

Debt levels are moderate at 4.1% of 2005 personal income. Amortization is below average, with 39% of GO debt maturing over 10 years. The governor's proposed strategic growth plan to address pent-up transportation, K-12 and higher education, and other infrastructure needs, including $25.2 billion in the first year, was not approved by the legislature in time for inclusion on the June ballot. A debt measure may be included on the November ballot if agreement can be reached.

The various purpose GO bonds are expected to mature Sept. 1, 2006, 2011-2023, and 2032-2035. The GO refunding bonds are expected to mature Sept. 1, 2006-2031. The bonds are callable beginning Sept. 1, 2016, at par.

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