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To: maceng2 who wrote (285)	7/30/2003 5:01:51 PM
From: maceng2	Respond to of 1417

Market insight: California debt not cheap enough By Jenny Wiggins in New York Published: July 30 2003 15:11 \| Last Updated: July 30 2003 15:11 news.ft.com. As the value of California's debt has sunk to historically cheap levels, investors are debating whether it's cheap enough to buy? The answer, so far, is a resounding no, leaving the state battling against rising financing costs as it prepares to issue more than $14bn in bonds to help cover a $38bn budget deficit. California, which once carried the top credit rating of "AAA", now has the lowest rating of all 50 US states after Standard and Poor's last week knocked it down to "BBB" - just two notches shy of a junk bond rating. The ratings agency was concerned about California's failure to adopt a 2004 budget on time and about the state's prospects for structural budget reform. The state's politicans have spent months bickering over whether to use tax increases or budget cuts to eradicate its budget gap. On Sunday, California's Senate finally approved a "compromise" budget that relies on spending cuts and borrowing rather than tax increases. After more than 24 hours of negotiating, the state's Assembly also passed the budget late Tuesday. Meanwhile, investors in some of California's $27bn outstanding in "general obligation" debt - repaid using tax revenues - have expressed their disappointment with the state's budget difficulties and ratings downgrade by selling bonds. California's debt is now trading at an historically wide yield spread of some 80 basis points more than "AAA" rated municipal securities and analysts expect that the spread could widen to as much as 100bps. Although credit ratings agencies Moody's Investors Service and Fitch have been less draconian than S&P in their evaluation of California - Moody's rates the state at "A2" and Fitch at "A" - the spread widening that followed the S&P downgrade will make it more expensive for California to sell its bonds. The state is planning to sell some $10.7bn more in bonds to help finance its deficit as part of the compromise budget deal, as well as an additional $2.2bn in pension bonds and $1.5bn in tobacco bonds. The cost of the debt sales will be further compounded by rising interest rates. This week, the yield on the 10-year US Treasury note reached it highest level in nearly a year. However, investors say the cheapening in California's debt prices may give them reason to buy. Investment firm Lord Abbett has only small exposure to Californian bonds, having worried six months ago that the state's fiscal health was deteriorating. But its portfolio managers do not believe California to be a "disaster scenario" and expect the state's lawmakers and politicans will eventually resolve the state's fiscal problems. They are now waiting to see whether California's debt will become cheap enough to buy. "The big question is: at what point is the market going to perceive Californian bonds to have reasonable value?" said Richard Smola, director of municipal bond mangement at Lord, Abbett. It appears that that point has not yet been reached. Investors' appetite for municipal bonds diminished in July, with retail investors pulling money out of municipal bond funds. Close to $500m was taken out of municipal bond funds in the week ending July 23 - the largest outflow since October, according to AMG Data. The selling has been spurred by the rise in Treasury yields - municipal securities tend to perform worse than Treasuries as yields move higher - and renewed interest in equities as investors become more hopeful that an economic recovery is on its way. Credit strategists are also wary of encouraging buying of Californian debt for the time being, given the state's budget difficulties. "We recommend avoiding California bonds until the budget issue has been resolved," said BCA Research in its August fixed income report. "Current spreads, though attractive, do not compensate for the risk that the delay in passing a budget leads to more serious problems."