Wildfire Liability and California Credit

No Repeat of a Credit Crunch Expected for the State of California as its Surplus Cash used for Utility Wildfire Fund

The news about California’s wildfire liability crises has focused on steps that could be taken to limit future wildfire liabilities for investor-owned utilities (IOUs), such as Pacific Gas & Electric and Southern California Edison, serving millions of California residents. However, legislation intended to stabilize the delivery of electricity to California residents and businesses could also have an impact on the future availability of funds used to repay the state’s general obligation (GO) and lease debt. Provisions of AB 1054, signed by Gov. Gavin Newsom on July 12, require the state to make a $2 billion contribution in the current fiscal year from state surplus funds to help capitalize the wildfire fund. The bill authorizes the state to lend up to $10.5 billion for the fund.Standard and Poor’s reported after AB 1054 was enacted that they believe the State of California has sufficient resources to fund its contributions to the wildfire fund, and we have not seen any concerns reported by Fitch or Moody’s. We note that the state’s credit quality has continued to improve in the current economic cycle, which is reflected in current GO ratings from Moody’s, Aa2 with a positive outlook, and AA- ratings from both Standard & Poor’s and Fitch. Furthermore, the legislation “intends” for the state’s contributions to be repaid within one year using proceeds from a new California Department of Water Resources (DWR) bond issue.Despite the state’s current credit stability, the new legislation may bring back bad memories for seasoned California investors, who may recall the precipitous decline of the its credit quality and liquidity after it began to use state resources to bail out the same IOUs during the power crises in the early years of the new millennium. Although the state had reached its credit peak in 2000, achieving AA ratings, by 2004 the use of surplus cash to purchase power for utilities led to a cash crisis. This was followed by a budget crippling recession, the recall of a sitting governor, and downgrades to the state’s BBB rating. There were even concerns that state GO bonds would fall into junk category.While we do not expect deterioration of the state’s credit quality at this time, monitoring the amount of contributions and repayments to the state will be a critical aspect of evaluating the California’s economic and financial performance. We also note that there are several mitigating factors as well as changes in the state’s governance that should provide more cushion for the state this time around.Sources: Standard & Poor’s, AB 1054Related: Why Risk Assets Are Not Reacting Dramatically to the Inverted Yield Curve