Fitch Upgrades $10B California Economic Recovery Bonds to 'AA-'.

NEW YORK -- Fitch Ratings upgrades the rating on approximately $9.9 billion economic recovery bonds (ERBs) of the state of California to 'AA-' from 'A+'. The upgrade is based on the state's economic and financial recovery and improved credit posture, reflected in today's upgrade of the California general obligation (GO) credit rating to 'A+' from 'A', and the shortening of the expected retirement date of the bonds.

Due to higher than forecasted collections from the special sales tax revenues pledged to the bonds and other revenues dedicated to ERB retirement, the bonds, which have a nominal final maturity of July 1, 2023, are now expected to be fully retired by January 1, 2010. This assumes that the state meets its full annual funding requirements for the budget stabilization account going forward, with half of these transfers required to be applied to ERB retirement to an aggregate not to exceed $5 billion. However, even if the transfers to the budget stabilization account are suspended for fiscals 2008 onward and sales tax grows at only 2% per year, well below the historical average, the ERBs are expected to be paid off by April 1, 2013.

The ERBs are general obligations of the State of California and carry a pledge of its full faith and credit. However, a one-quarter cent sales tax is pledged to the bonds. The ERBs are rated higher than the state GO credit due to the exclusivity of the pledged tax for the bonds and the coverage provided from sales tax revenue, a stable, strong source. Additional security is provided by a coverage account equal to 25% of annual debt service. The fiscal recovery fund that receives the pledged tax is insulated from the state's financial operations and its balances cannot be borrowed. Since the pledged tax is solely for the benefit of the bonds, excess revenues are applied to early redemption of the bonds.

Additional ERBs are permitted, assuming that debt service on senior bonds is covered 1.15x through fiscal 2008 and 1.10x thereafter. If subordinate obligations are issued, the test is 1.0x for total debt service. The ERB authorization is limited to $15 billion; $11 billion in ERBs have been issued to date, and the state has no plans to issue additional ERBs. Proceeds of the ERBs have been used to clear California's accumulated deficit including obligations incurred to June 30, 2004.

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