High yields in California bond sale could tempt investors

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California may be forced to pay some rich yields next week to sell $4 billion in tax-free general obligation bonds.

That could present an opportunity for income-hungry investors in mid- to upper-income tax brackets.

As of Thursday, the talk in the market was for annualized yields of about 4% on the five-year bond in the deal and about 5% on the 10-year issue, just to give two examples.

Because that interest is exempt from state and federal income tax for California residents, the yields are equivalent to much higher interest rates on taxable investments, such as corporate or U.S. Treasury bonds, depending on your tax bracket.

For a married couple filing a joint return, taxable income of about $71,000 puts you in the 31% combined federal and state marginal tax bracket. A 4% tax-free yield in that bracket is equivalent to a 5.8% fully taxable yield.

If you’re tempted, first note that to order the bonds you must have a brokerage account. The long list of brokerages participating in the deal is available on the bond prospectus, which you can reach via the state’s buycaliforniabonds.com website.

Treasurer Bill Lockyer is actively courting individual investors via print and radio ads for the bonds, which will be sold in maturities of one year to 30 years. The minimum investment is $5,000.

Lockyer is hoping for a big turnout by individuals; the more they buy, the less power institutional investors may have to force up yields. . . .

Institutions such as mutual funds and insurance companies are more likely than individuals to focus on the state’s low credit rating, a byproduct of Sacramento’s ongoing budget woes. Standard & Poor’s and Moody’s Investors Service both give California the lowest rating of any of the 50 states -- A and A2, respectively.

But as Lockyer is quick to note, the state constitution mandates that principal and interest payments must be made. California, he vows, would never default on its debts, short of Armageddon.

When the state sold $5 billion in short-term IOUs last fall, individual investors grabbed 80% of the securities. In the state’s last bond sale, in June, individuals bought about half of the offering.

Here’s how the deal will work: Individuals will have a chance to place orders with brokerages on Monday and Tuesday. The state will give an expected range of yields for each maturity, but won’t guarantee them at that point.

On Wednesday, institutional investors will put in their orders, and the yields will be set. Individual investors who don’t like the final yields will be able to cancel their orders. Typically, though, the final yields are pretty close to the initial estimates.

-- Tom Petruno