State sets preliminary yields on $10-billion note sale

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California on Monday set tentative interest rates of 1% to 1.5% on its mammoth short-term debt offering, hoping to lure individual investors who are hungry for tax-free yields.

The state is borrowing $10 billion via so-called revenue anticipation notes, or RANs. These are short-term notes that the state typically has sold each autumn to tide it over until tax revenue arrives later in the fiscal year.

The notes are in two issues, one maturing May 25, 2011 and another maturing June 28. Brokerages taking orders for the notes are telling investors that the May issue is expected to pay an annualized yield of 1% to 1.25% and the June issue 1.25% to 1.50%. The interest is exempt from federal and state income tax.

How the offering works: Via brokerages, the state will accept orders Monday and Tuesday from individual investors. (Minimum investment: $5,000.) On Wednesday institutional investors, such as money market funds, will put in their orders. That’s when the final yields will be set, and they could be higher or lower than the preliminary range, depending on the volume of demand.

If individual investors aren’t happy with the final yields they can cancel their orders.

The yield range in similar to what the state offered on the $8.8-billion in RANs it sold in September 2009. The final yields on those RANs were 1.25% on the May issue and 1.50% on the June issue.

The state is paying well above the interest rates available on most short-term securities. One-year U.S. Treasury bills, for example, pay 0.26%. The higher rates reflect the state’s chronic budget shortfalls and overall low credit rating compared with other states.

Still, the two best-known credit-rating firms, Standard & Poor’s and Moody’s Investors Service, last week gave the RANs their highest-quality ratings, although S&P’s rating of SP-1 was one notch below its ultimate grade of SP-1-plus. A third firm, Fitch Ratings, gave the securities its second-highest overall rating, F2, but that’s two notches below its ultimate grade of F1-plus.

The ratings are based in large part on the state’s ability to manage its cash so that it will have enough on hand to repay the notes in full on their maturity dates, even if its budget situation worsens.

But note: The RANs have no federal guarantee, so they aren’t appropriate for people who want the iron-clad guarantee they can get on bank savings certificates.

-- Tom Petruno