Bloomberg News

Thursday, June 12, 2003 - California, with the lowest credit rating among U.S. states, paid about twice as much as comparable borrowers, a penalty of $109 million, to sell one-year warrants needed to pay the state's bills.

"California can't go on forever living on borrowed money," said Claire Cohen, Fitch Ratings vice chairwoman. "At some point, the market is going to change its mind" about lending.

The biggest U.S. state will pay an average of 1.13 percent to investors who bought $11 billion of warrants in the largest such sale ever, Controller Steve Westly said during a conference call with investors from Sacramento. Financing costs rise to

1.9 percent when credit guarantees are included, he added. That compares with a yield of 0.9 percent for similar debt sold by Los Angeles County and California schools.

The high cost of financing is a sign of investors' concern that the state will run out of money because of a budget standoff between the legislature and the governor. Westly has said the state will be out of cash -- and Wall Street may not lend more -- if a budget is not in place by about Aug. 1. The state is scheduled to sell another $8.2 billion in debt this year.

California is paying the highest yields among U.S. states to sell bonds and plans a $1.7 billion general obligation debt issue on June 19. Standard & Poor's Wednesday affirmed its A rating on California's bonds.

"Wall Street is looking for us to put our house in order," Westly said. "It's going to be very difficult" for the state "to do any additional borrowing until a budget is done and much, if not all, of the structural deficit is taken care of."

The higher interest rate will cost the state about $25 million more this year than other borrowers. California, the world's fifth-largest economy, also paid seven investment banks an extra $84 million fee to guarantee the securities in case the state doesn't generate enough tax revenue to repay them at maturity next June.

California lawmakers remain at odds over closing a $38 billion deficit, the largest among U.S. states, and may miss a Sunday deadline for passing a budget plan. The budget impasse, combined with the size of Wednesday's sale and the state's need to add credit guarantees, pushed yields higher than other municipal borrowers, investors said.

"It's a shame that we had to pay the $84 million" to arrange the bank guarantees, Westly said. "I think the public will understand" that the 1.13 percent rate "is a good thing for a state in this financial condition."

Westly said he estimates the state would have spent $134 million, or $50 million more than the credit enhancement, in interest if the state sold the warrants without the banks' credit backing.

"You've got to gauge California's debt cost relative to other states," said Jonathan Coupal, president of the Howard Jarvis Taxpayers Association. The state is "borrowing to the hilt with no real plan in place" to address chronic deficits "and people wonder why Wall Street thinks we're nuts."