Needy for yield? California launches a big tax-free bond sale

California has had great luck selling tax-free municipal bonds to yield-hungry investors this year. The state is trying again today: It has $1.5 billion in general obligation bonds up for sale.

As a place to stash money away at a decent interest rate, it’s hard to argue against California’s bonds -– despite the state’s worsening economy and budget.

Brokerages handling the sale for the state will be taking orders through 5 p.m. PDT today from small investors, and on Monday provided there are bonds left, according to Treasurer Bill Lockyer’s office. (The minimum order: $5,000.) Institutional investors will bid on Tuesday, and that’s when the final yields on the bonds will be set.

As usual, the securities are being offered in maturities of one to 30 years. Proceeds will be used to fund infrastructure projects and to pay off higher-cost debt.

The recent general rise in interest rates means the state will have to pay more on the bonds than it would have a few weeks ago -- good for investors, if not for taxpayers.

Expectations are for a tax-free annualized yield of about 4.33% on the 10-year bond issue, said Cameron Gloege, a bond trader at Wedbush Morgan Securities in L.A.

By contrast, the state paid 4.15% on 10-year bonds at its last big debt sale, in early April.

Here are ballpark yields for other bonds in the current offering: 2-year, 2.7%; 5-year, 3.56%; 20-year, 4.93%; and 30-year, 5.1%.

Because those yields are exempt from state and federal income taxes for California residents, they’re much better than they look, depending on your tax bracket. For a married couple in the 31% federal and state marginal tax bracket (that bracket begins at taxable income of $70,921), a 3.56% tax-free yield is equal to a fully taxable yield (such as on a bank CD) of 5.16%.

How safe are California bonds? Despite Sacramento’s latest budget mess, debt repayment is mandated by the state Constitution. See this recent post I wrote for more on the safety issue.

Note: The shorter-term bonds usually are very popular with small investors, which means they often quickly sell out.

A final reminder: You have to buy via a brokerage. The state doesn’t sell its securities directly to investors.

Photo: The Capitol in Sacramento. Credit: Robert Durell/Los Angeles Times

Comments

[Clard]

No comments on their insurance, or lack of it?

[Jennifer]

you can get 5% on a 10-year CD (www.money-rates.com) that comes with FDIC insurance so I don't get why you would want the risk of no insurance for 70 points less per year?

[Gil]

Jennifer: You have to calculate the taxable equivalent yield to make the comparison you're making. The 4.33% tax-free bond actually yields more than 6% and as much as 7% depending on your tax bracket.

You are picking up more than 100 basis points on the muni bond (over the CD you mention) as a California resident, and that is if you're in the 25% federal and 6% state tax brackets. An investor in the highest tax bracket would earn roughly 250 basis points more than the CD you mention.

[jdj]

The insurance was never to guarantee the bonds, just to lower the yields the state would have to pay.

No one ever really believed that an insurance company would have enough money to pay claims on principal and interest if California defaulted on all its debt.