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As California State Controller John Chiang warned only weeks ago, putting the state in the position of submitting IOUs as payments would send creditors a negative message.
Fitch Ratings Services has lowered its long-term rating on California's general obligation (GO) debt to 'BBB' from 'A-'. The agency had just lowered the rating to 'A-' from 'A' on June 25. 'BB+', a mere two notches away from the current rating, would be considered "speculative grade" -- a.k.a. "junk bonds." The other major agencies, Standard & Poor's (which rates the state's GO debt 'A') and Moody's ('A2'), have not yet made similar moves since Chiang took the step of issuing IOUs.
According to Fitch, the downgrade was based on the California's "continued inability to achieve timely agreement on budgetary and cash flow solutions to its severe fiscal crisis." Fitch's announcement says that the state's issuance of IOUs is projected to help with cash shortfalls into September 2009, but the "margins for meeting constitutional and court-required contractual commitments are narrowing." Importantly, the ratings service points out that "Cash flow solutions, including the ability to access short-term borrowing, are inextricably tied to reaching timely agreement on effective and credible budget solutions."
Fitch is maintaining its 'Rating Watch Negative' status on California's debt, reflecting the near-term possibility that Fitch will again downgrade the rating. The current 'BBB' rating, while "well below that of most other tax supported issuers," still indicates a low default risk.
