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California muni bond sales lure investors after market yields jump

November 19, 2010 |  9:40 pm

The battered municipal bond market recovered a bit more on Friday, and California was a beneficiary.

Treasurer Bill Lockyer said the state was able to sell all $3.275 billion of taxable bonds it offered to investors, even after boosting the size of the deal from an original $2 billion.

And on the first day of the state’s offering of $1 billion in tax-free bonds, orders placed by individual investors exceeded the amount of bonds reserved for them.

In the muni market overall, traders said investors were moving off the sidelines to bid for bonds after yields surged over the last week.

“Retail buyers are starting to show up again,” said Bud Byrnes, head of muni brokerage RH Investment Corp. in Encino.

The annualized yield on the Bond Buyer index of 40 long-term muni bonds nationwide fell for the first time since Oct. 28, easing to 5.34% Friday from 5.51% on Thursday. The yield had rocketed from a 52-week low of 4.86% in mid-October, with most of the jump occurring just this week.

Calflag The muni market has been hit hard as longer-term interest rates in general have rebounded this month. A heavy supply of new muni issues, including from California, swamped the market at a point when some investors had lost their appetite for bonds.

California paid a price for the market turmoil -- literally. The state’s offering of $10 billion in short-term notes early this week failed to attract enough investor bids to fill the entire deal. The state received $6.06 billion in orders from individual investors but a disappointing $3.25 billion from institutional investors. So the brokerages handling the sale had to take the final $750 million of the notes.

The state also had to bump up the tax-free yields on the notes by a quarter-percentage-point, to 1.50% on the series maturing in May, 2011 and 1.75% on the series maturing in June.

But as buyers returned to the muni market on Friday the state fared better with its sales of longer-term general obligation bonds that fund voter-approved infrastructure projects.

The $3.275 billion in taxable bonds were mostly issued as federally subsidized Build America Bonds, which have become highly popular with insurance companies, pension funds and foreign investors since the program was launched in 2009.

California sold 30-year BABs at a yield of 7.52%, or 3.25 percentage points above the yield on 30-year U.S. Treasury bonds. On Thursday bond dealers had expected the state to pay a slightly wider premium of 3.30 points above Treasuries.

The federal government foots the bill for 35% of the interest on BABs. So the state’s net interest cost on the 30-year issue was an annualized 4.89%, well below the 5.5% market yield on 30-year tax-free California bonds.

To save money, Lockyer boosted the size of the taxable BAB bond deal while shrinking a planned sale of tax-free bonds to $1 billion from $1.75 billion.

On Friday the state offered $525 million of the tax-free deal to individual investors while reserving $475 million for institutions. Lured by the jump in muni yields this month, individuals put in orders totaling $838 million for their portion, which means that that part of the deal was oversubscribed: Unless the state changes some of the allocations or increases the size of the deal, some individual investors won’t get the bonds they sought.

Tom Dresslar, Lockyer’s spokesman, said he couldn’t speculate on whether the state would boost the size of the offering or how many individual-investor orders might go unfilled. The outcome may depend on whether institutional investors take their full allotment early next week.

The state is offering preliminary tax-free yields ranging from 2.68% on the five-year bonds in the deal to 4.26% on the 10-year issue and 5.38% on the 25-year issue.

The strong investor demand for the bonds was a good sign for the state, of course. But taxpayers still will be footing a bigger interest bill because of the recent jump in yields.

About a month ago 10-year tax-free California bonds were yielding about 3.75%, for example –- a half-percentage-point less than what the state is offering now. We can thank Sacramento for the bad timing.

-- Tom Petruno

Photo credit: Makaristos

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