California's Default Follow-Up: How Did It Not Happen?

by: Carl Dincesen

It looks like California hasn’t defaulted, not even on the State’s revenue anticipation notes. They were the subject of an earlier alert about a probable default rate much higher than the market was reflecting at the time.

So what happened? There did not even appear to be a struggle to redeem seven billion dollars in cash flow notes this past June. Three of the original ten billion matured the month before.

That without having or trying to issue new notes to pay-off the old. In fact, because of budget approval delays and a market that was strongly suggesting that new borrowing would not be received well, if at all.

I could not figure out where the ten billion dollars came from to redeem the notes. It did not appear to come from the banks at all.

The only thing that I could think of was the $10 billion the cash-strapped state had in unexpended proceeds of capital construction state general obligation bonds. I have no idea that this is the case.

But in my experience, issuers are typically not permitted to co-mingle or invest bond proceeds in themselves. So, I decided to find out not how the State escaped defaulting on its notes, but instead what the law is concerning investment of bond proceeds pending disbursement for capital construction.

To my surprise, I could not even find a reference to where proceeds are held let alone what investments are permitted pending disbursement. That is based on looking at the official statements for two recent California general obligation bond issues.

Well let’s just say that disclosure is not what it used to be.

Benchmark Bond Ratings advises that its Protection Margin Rating of “06 – Less Than Thin,” rating agency bond equivalent CCC, CC & C, on the State's revenue anticipation notes has expired.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.