California expects to pay high yields on short-term notes

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It looks like California will pay a steep price to borrow short-term cash to patch its seasonal budget shortfall.

The state’s pain is your gain, if you’ve got money to put to work.

Treasurer Bill Lockyer this morning announced the range of tax-free yields the state expects to pay on so-called revenue anticipation notes that will be sold Thursday:

-- For the notes maturing on May 20, 2009, the annualized yield is expected to be between 3.75% and 4%.

-- For the notes maturing on June 22, 2009, the state expects to pay between 4.25% and 4.5%.

Because those returns are exempt from state and federal income tax for California investors, they’re very juicy compared with interest rates on other short-term securities.

A 4% tax-free yield, for example, is equivalent to a fully taxable yield of 5.88% for a couple in the 32% combined state and federal tax bracket (which begins at taxable income of $89,629).

‘These are unusually high yields,’ said Matt Fabian, senior analyst at Municipal Market Advisors in Westport, Conn. Because the credit crisis has hit the municipal bond market particularly hard, ‘Everybody’s paying through the nose,’ he said.

The state is expected to sell up to $5 billion of the notes in all.

How the sale works: Individual investors are invited to place orders today and Wednesday. Institutional investors then bid Thursday, and that’s when the final yields are announced.

Individuals who aren’t satisfied with the final yields can cancel their orders Thursday.

The minimum investment is $5,000. Investors must place orders via a brokerage (the state doesn’t take orders directly).

For more on the notes, go to Lockyer’s website, here.

For a basic primer on buying California municipal bonds, go here.