Fitch Rates $592.9 MM California Public Works Board Bonds 'BBB+'; Outlook Stable

NEW YORK--(BUSINESS WIRE)--

Fitch Ratings assigns a 'BBB+' rating to the following lease revenue bonds of the State Public Works Board (PWB) of the state of California (the state):

--$489.8 million (Judicial Council of California) 2011 series D (various Judicial Council projects);

--$96.1 million 2011 series E (various capital projects) (federally taxable bonds);

--$6.9 million (Department of Mental Health) 2011 series F (renovation of hospital addition at Atascadero State Hospital)

(federally taxable bonds).

Par amounts may vary at final sale, expected via negotiation on November 1. In addition, Fitch affirms the following ratings:

--Approximately $7.3 billion in outstanding state appropriation bonds of the PWB and certain other agencies at 'BBB+'.

The Rating Outlook is Stable.

KEY RATING DRIVERS

--The 'BBB+' rating, one notch below the state's general obligation (GO) rating, reflects the appropriation required for debt service payment and the state's underlying credit characteristics.

--A persistent structural budget imbalance, revenue cyclicality and institutional inflexibility, particularly due to voter initiatives, have led to repeated severe budget and cash flow crises. Modest but uneven revenue growth has returned, although achieving the state's near-term revenue growth forecast is an uncertainty.

--Institutional weaknesses, including constraints imposed by voter initiatives and a contentious policy-making environment, have repeatedly delayed action on addressing fiscal challenges and historically have resulted in unsound budgetary solutions.

--The state's current year budget relies primarily on structural solutions, although spending pressures and implementation risks remain.

--The economy is broad, diverse and wealthy, with growth resuming after severe recessionary conditions.

--Debt levels remain moderate but above average, having grown both for infrastructure and gap-closing. Lease debt carries appropriation and abatement risk.

--Pension system funded ratios have declined although some reforms have been undertaken.

SECURITY

Secured by lease rental payments made by various agencies to the PWB for use and occupancy of the facilities, subject to state legislative appropriation.

CREDIT PROFILE

The PWB is the state's primary means of financing state facilities, with bonds benefiting from a strong lease structure and the essential nature of leased assets. Debt service is paid from lease rental payments made pursuant to specific project leases. Lease rental payments are appropriated annually by the legislature, with the lessee agency required by law to use the first funds appropriated to it for lease payments on PWB debt. Abatement is possible, but projects require rental interruption insurance. The series are secured further by the PWB's $143 million master indenture reserve, which backs $8.4 billion in outstanding PWB lease bonds prior to this sale.

The state's 'A-' GO bond rating and Stable Outlook reflect the continuing magnitude of its fiscal challenges and limited flexibility in the context of persistent structural deficits and institutional impediments to sustainable budget-making. These credit weaknesses are offset in part by the size and breadth of the state's economy and tax base and the strengths inherent in a state's broad powers.

State economic and revenue performance has improved since the downturn, leading to more stable cash balances and reducing immediate budgetary stress. The adopted budget for fiscal year (FY) 2012 incorporated sizable recurring solutions, primarily spending cuts, which if achieved and sustained would materially reduce the state's longstanding structural gap. Numerous near-term risks remain, including attainment of the state's FY 2012 revenue target and successful implementation of budgeted solutions. Moreover, the state has accumulated substantial unpaid obligations from the last two fiscal crises, and numerous voter measures and a politically contentious environment continue to hamper its ability to effectively respond to fiscal challenges.

The recession and fiscal crisis that began during FY 2008 was the most severe faced by the state in decades. Volatility of state tax revenues, particularly personal income tax (PIT) receipts tied to capital gains, has long been a key state credit challenge. The state notes that collections of its top three revenue sources, PIT, sales and corporation taxes, dropped 25% between January 2008 and January 2011. Over that period the state adopted more than $100 billion in budget solutions, the vast majority of which were one-time in nature, such as use of federal stimulus, spending deferrals, asset sales, or fund transfers. Many of the state's budget solutions failed to materialize.

The on-time budget for the current fiscal year, adopted on June 30, closed a cumulative gap for FY 2011 and FY 2012 estimated by the governor in January 2011 at $25.4 billion. The gap was resolved with spending cuts ($15 billion), primarily to human services and education, tax and fee measures ($948 million), fund transfers and loans ($2.9 billion), and increased revenue estimates ($8.3 billion). The spending cuts were enacted by the legislature under an initiative passed by voters in November 2010 that allows the legislature to enact spending measures on a simple majority basis. Although this measure clearly increases the state's fiscal flexibility, other voter measures approved at that time further restricted state taxing power and access to non-general fund resources.

The $8.3 billion in higher revenue in the adopted plan includes both baseline forecast growth from the governor's May 2011 revised budget proposal following strong April 2011 collections, and $4 billion in unspecified receipts assumed during FY 2012. The additional $4 billion, which is not allocated to any specific revenue source, was a key component of final budget negotiations and was based on strong cash collections in late fiscal 2011 that were exceeding the governor's May 2011 forecast. This trend has weakened since July 1, the start of fiscal 2012, with the controller reporting actual receipts through September 2011 year-to-date falling $706 million (3.6%) below the budget target.

Achievement of FY 2012 revenue targets remains the greatest source of budget uncertainty in the near term. To hedge against the risk of revenue underperformance, the budget includes up to $2.5 billion in additional spending cuts that would be triggered without further legislative approval beginning in January 2012 if the updated revenue forecast is below the adopted budget projection by more than $1 billion. The budget also incorporates several ambitious initiatives to restructure government, including a shift of state functions (primarily public safety and human services) to counties and the reorganization of local redevelopment agencies, the latter now subject to legal challenge.

The state benefits from an economy that is unrivaled in its diversity. Broader growth is now taking hold after severe, widespread recessionary conditions that were much worse than the national experience. August 2011 employment rose 1.2% from August 2010, higher than the 1% national rate for the same period. Unemployment in the state remains high, at 12.1% in August 2011, compared with 9.1% nationally. Employment growth has been widespread, including construction, manufacturing, and most services, although pockets of weakness remain. Personal income gains have resumed, with the second quarter of 2011 rising 6.4% from the year before, ahead of the 5.4% national rate. The state's current economic forecast, released in May 2011, anticipates slow gains in economic activity going forward; updated forecast assumptions will be released with the governor's budget in January 2012.

The state has a moderate but above-average and rising debt burden, with net tax-supported debt of approximately $90.5 billion as of Sept. 1, 2011, equal to 5.6% of 2010 preliminary personal income. The debt burden has risen over the last decade due primarily to substantial GO bond issuance for infrastructure, although significant bonding has been undertaken to close operating budget gaps as well.

Funded ratios for the state's two main pension systems, covering public employees and teachers, remain adequate on a reported basis despite losses due to the market downturn. The public employees' plan reported an 83.3% system-wide funded ratio based on its June 30, 2009 actuarial valuation, and the teachers' plan reported a 71.5% system-wide funded ratio based on the June 30, 2010 actuarial valuation. Using Fitch's more conservative 7% discount rate assumption, funded ratios for the two systems would fall to 77% for public employees and 66% for teachers. Some reforms to contribution levels and benefits were adopted with the state's fiscal 2011 budget, and the teachers' system reduced its discount rate assumption to 7.75%, from 8%. Full actuarial contributions to the public employees' system are legally required, but not for the teachers' system, leading to consistent underfunding of the latter.

Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

In addition to the sources of information identified in the Tax-Supported Rating Criteria, this action was additionally informed by information from IHS Global Insight.

Applicable Criteria and Related Research:

--'Tax-Supported Rating Criteria' (Aug. 15, 2011);

--'U.S. State Government Tax-Supported Rating Criteria' (Aug. 15, 2011).

Applicable Criteria and Related Research:

Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648898

U.S. State Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648897

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