Cash Position: Strong Despite Fund Drawdowns

California's recently released cash flow projection for fiscal 2021, based on its enacted 2021 budget, indicates its cash position will remain strong in our view, at least for the current fiscal year, despite budgeted drawdowns in the state's rainy day fund. However, large projected out-year budget gaps could reduce the state's cash position in future years, absent structural budget adjustments next year and beyond.

The state's cash position remains an important factor in retaining our current GO rating of AA-/Stable. In previous recessions, the state's cash position became strained--the result of its dependence on cyclical income tax revenue from top taxpayers. Our rating incorporates an expectation that the state's financial results will continue to show above-average fluctuation over an economic cycle, but also assumes the state will be able to maintain adequate liquidity with the use of internally borrowable funds. In normal years, the state's general fund cash position reaches a low point in March, before April income tax returns come in.

Currently, we view California's cash position as strong. The state projects that cash and unused borrowable resources from all funds will total a large $37.9 billion at fiscal end June 30, 2021, compared to fiscal 2021 full year general fund cash disbursements of $143.8 billion.

The general fund's Special Fund for Economic Uncertainties (SFEU) is projected to total $2.6 billion at fiscal end 2021, while the rainy day fund, or Budget Stabilization Account (BSA), is projected to end with $8.3 billion. Of that total $10.9 billion, $5.8 billion would be internally loaned to the general fund at fiscal end 2021. The remaining fiscal end 2021 available cash balance comes from $32.8 billion of other borrowable funds.

The state projects no need for external cash flow borrowing in fiscal 2021. At its month-end low point in March 2021, the general fund in fiscal 2021 would need to borrow internally from other funds $19.6 billion, or only $8.7 billion after borrowing from the BSA and SFEU.

Available cash levels may fall after fiscal 2021, however. The state's multi-year forecast projects combined general fund and BSA reserves will fall to a negative $2.7 billion at fiscal end 2022 from a positive $11.4 billion at fiscal end 2021 without budget adjustments in future years.

While overall cash may remain good due to non-general fund balances, cash balances are likely to decline over time. The state projects its annual general fund operating deficit, after drawing on its BSA, will rise from $8.7 billion in fiscal 2022, or 6.3% of general fund expenditures, to $17.7 billion, or 11.6% of expenditures, by fiscal 2024, without future budgetary gap closing actions.

The total projected cash and unused borrowable resources of $37.9 billion at fiscal end 2021 is nearly the same as the $37.3 billion actual amount at fiscal end 2020 (see chart). However, this is in part due to the temporarily depressed cash position in 2020 following the extension of the income tax filing period from April to July, whereas borrowable cash through most of the rest of fiscal 2020 was much higher. Available non-general fund borrowable resources, excluding the BSA and the SFEU, are projected to decline from $40.8 billion at fiscal end 2020 to $32.8 billion at fiscal end 2021.

Enacted Fiscal 2021 Budget

California enacted its fiscal 2021 budget at the end of June. The budget draws down reserves to what we view as still good levels at fiscal end 2021. However, the pace of the drawdown, combined with use of significant one-time budget adjustments, could lead to structural budget pressures in fiscal 2022 and beyond.

California projected in May a $54.3 billion general fund budget gap for the one-and-a-half year period combining the last half of fiscal 2020 and all of fiscal 2021, compared to its earlier revenue forecast made in January. The final adopted budget met the $54.3 billion gap primarily through the use of reserves, reduced K-14 school and university spending, use of federal funds, cancellation of some program expansions the governor had proposed in January, a temporary elimination of a business tax break, and various other measures.

From fiscal 2020 to fiscal 2021, K-12 education aid is budgeted to decline $6.8 billion, or 12.4%, while higher education spending is budgeted to decline $1.3 billion, or 7.5%. At the same time, health and human services will see an increase of $2.9 billion, or 6.9%, although this increase should be largely offset by increased federal Medicaid reimbursements and other aid.

The "sudden stop" recession caused a significant reduction in the state's revenue projections. The state estimates general fund budgetary revenue fell 3.3% on a preliminary basis in fiscal 2020, including accrual of income tax due under an extended July 15 filing deadline back to fiscal 2020. Budgetary basis revenue is budgeted to decline a further 7.0% in fiscal 2021, not including reserves as revenue.

We calculate that on a budgetary basis of accounting, and not including use of reserves as a revenue, the state's general fund had a preliminary operating deficit equal to 4.9% of general fund expenditures in fiscal 2020 before use of reserves, and is budgeting a 3.0% operating deficit in fiscal 2021 before use of reserves (see table).

Table 1

The state's multi-year forecast projects very significant operating deficits in fiscal 2022 and beyond without future budgetary action. As stated above, the projected out-year budget gap to solve in fiscal 2022 (after expected use of transfers from the BSA) amounts to 6.3% of projected general fund expenditures, rising to 11.6% in 2024.

The projected operating deficits would reduce general fund reserves, including the BSA and SFEU, to $11.4 billion, or 8.5% of expenditures at fiscal end 2021, a level we would still view as strong, although down from 15.0% at fiscal end 2019. At fiscal end 2021, assuming no additional federal aid, there would be $12.5 billion in cumulative deferred cash payments to K-14 schools.

The enacted 2021 budget also contains triggers that could increase school aid and certain other programs by if additional federal aid is received by Oct. 15.

Significant budget closing actions to eliminate the $54.3 billion budget gap consist of:

• $8.8 billion draw down in reserves, including $7.8 billion from the BSA;
• $11.1 billion of school aid deferrals and other spending cuts if additional federal aid is not received by Oct. 15, consisting in part of: $6.6 billion deferred spending on schools; $2.8 billion state employee compensation; $970 million for the University of California; $250 million for county programs; $150 million for courts
• $10.6 billion of cancelled proposed program expansions, cuts, and updated budget assumptions, including lower health and human services caseload costs;
• $10.1 billion of federal CARES Act aid, including an increased Medicaid reimbursement rate--of this, $8.1 billion has already been received;
• $4.4 billion new revenue from reduced corporate tax credits and other measures; and
• $9.3 billion of borrowing, transfers, and spending deferrals, consisting of: $5.3 billion of K-12 school spending deferrals; $1.0 billion for community colleges school spending deferrals; $2.1 billion in various loans to the general fund from other funds; $0.9 billion in transfers from the State Project Infrastructure Fund and other funds.

Of note, many of the above budget solutions consist of one-time general fund adjustments, which will create a structural budget hole going into fiscal 2022 when these adjustments are no longer available. The state estimates one-time budget measures total what we view as a large $24.1 billion, or 18% of budgeted expenditures.

The one-time budget solutions include:

• $8.8 billion withdrawal from the BSA and general fund related reserves;
• $3.0 billion of loans from special funds;
• $0.9 billion in revenue transfers;
• $5.3 billion of federal FMAP assistance, that currently expires Dec. 31, 2020;
• $975 million of CalPERS payments made from prior years' set asides;
• $1.8 billion for COVID-19 federal funds offset; and
• $2.0 billion in assumed federal funds to provide general fund relief.

School Payment Deferrals

The school payment deferrals are actual fiscal year reductions in aid to school districts, but under Proposition 98 must be restored as general fund revenue grows in future years. The state has structured the deferrals so that they are weighted toward the end of the fiscal year, allowing some of the aid to be restored if additional federal aid is received mid-year. Altogether $2.2 billion of fiscal 2020 school aid was deferred into fiscal 2021, and $12.5 billion of fiscal 2021 school aid is deferred into fiscal 2022, of which $6.6 billion would be restored in fiscal 2021 if full federal reimbursement were received by Oct. 15, 2021 (see table 2).

Table 2

School deferrals work by paying what would have been paid in June in July--the next fiscal year. Likewise, certain payments normally due in May will be paid in August, certain payments normally paid in April will be moved to September, and so forth, through February's estimated $1.5 billion deferral of school aid from February to November. The school aid deferrals represents an actual cut in payments made during the fiscal year, but the deferrals would be phased back in to school districts in future years to the extent that general fund revenue grew, or additional federal aid is received.

Cash Should Be Adequate Even If Revenues Soften Somewhat

The unpredictability of COVID-19 means that every state budget is at the mercy of future events. California's budget assumes a slow gradual economic recovery in fiscal 2021, but a major renewed outbreak of the coronavirus could reduce economic activity and push revenue below projected levels. The Department of Finance's July monthly revenue report shows revenue very slightly ahead of the May forecast through fiscal end June 30, 2020. However, it is still too early to know what might happen this fall. Nevertheless, due to the large projected cash position throughout fiscal 2021, we do not expect the state's cash position to pose credit issues in the coming year, even if revenues prove soft.