State credit rating may be cut further

California’s credit rating, already the lowest of the 50 states, may be cut again, Standard & Poor’s warned Tuesday.

As the debate over budget cuts drags on in Sacramento, S&P; put its “A” grade on the state’s $59 billion in general obligation bonds on “negative credit watch,” meaning the rating is at risk of a downgrade.

Using language that could further spook bond investors, S&P; said, “Although we continue to believe the state retains a fundamental capacity to meet its debt service, insufficient or untimely adoption of budget reforms serve to increase the risk of missed payments.”

The Legislature and Gov. Arnold Schwarzenegger are facing a $24.3-billion budget shortfall, and Controller John Chiang has warned that the state could run short of cash beginning July 28, just one month into fiscal 2010.

The Obama administration repeated Tuesday that it wouldn’t offer special financial assistance to California.

“We’ll continue to monitor the challenges that they have, but this budgetary problem unfortunately is one that they’re going to have to solve,” White House Press Secretary Robert Gibbs said in Washington.

Worries about the state’s fiscal fate, combined with an early-June jump in U.S. Treasury bond yields, have pushed market interest rates on the state’s outstanding bonds sharply higher since mid-May. Yields on bonds rise as their prices fall.

Tax-free yields on 10-year California general obligation bonds were 5% to 5.1% on Tuesday, according to several traders. The yield was under 4.4% in mid-May.

A further credit downgrade could spur investors to force the state to pay even higher interest rates when it borrows.

Still, California Treasurer Bill Lockyer has insisted all through Sacramento’s deepening budget woes that he would never allow the state to renege on what it owes bondholders.

S&P;’s language Tuesday incensed Lockyer’s spokesman, Tom Dresslar. “S&P; raises undue alarm about the potential for missed bond payments,” he said. “There is zero chance of that happening.”

Payment of interest and principal on the state’s general obligation debt is mandated by the state Constitution.

S&P;, in its statement Tuesday, estimated that constitutionally required spending on education would be $36 billion in fiscal 2010. Under the law, bond principal and interest payments of $5.7 billion for the year then would have to be funded before the state could pay other expenses.

S&P; estimated that, after funding education, the state would have $53 billion in resources to cover debt service.

Although the revenue coverage of the debt service for the year appears to be more than adequate, S&P; said it was concerned about cash flow -- whether month to month the state would have the cash to make debt payments.

“Even if revenue for the year is sufficient to meet high-priority payments for education and debt service, we believe the timing of cash inflows and outflows could cause acute liquidity shortages with the potential to present relatively serious credit concerns,” the firm said.

Dresslar said the state knows when debt payments are coming due and will husband cash accordingly. “We are not going to miss any payments,” he said.

S&P; analyst Gabriel Petek, who co-authored the California report, said S&P; wasn’t implying a high danger of default. Although the firm warned that it might lower the state’s credit grade, the current rating of “A” still is an investment-quality grade, he noted.

“The rating conveys that we don’t think they will miss a payment,” Petek said.

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tom.petruno@latimes.com