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The rich were on their way to getting richer today -- if they were buyers of long-term tax-free bonds in California’s $1.5-billion debt offering. The not-so-rich fared OK too.
The market for municipal bonds in general has turned rocky in recent weeks, favoring buyers over sellers and pushing interest rates higher. That forced the state to pay up to sell its longest-term issues in today’s offering.
The 30-year issue in the deal will pay interest at a 5.3% annualized rate, compared with 4.96% on 30-year bonds the state sold in early April. Because interest on the bonds is exempt from state and federal income tax, that 5.3% is equivalent to a much higher taxable yield (such as on a corporate bond or bank CD), depending on an investor’s tax bracket.
 For the already very well-heeled -- Californians with taxable income of $1 million or more, which puts them in the 41.7% combined federal and state income tax bracket -- a 5.3% tax-free yield is the same as earning 9.1% on a taxable investment.
Further down the income ladder, a married couple in the 32% combined tax bracket (taxable income of $89,629 to $131,450) would have to earn a taxable yield of 7.8% to equal a 5.3% tax-free yield.
The state also sold shorter-term bonds in the offering, as is usual in such deals. The five-year issue, for example, will pay 3.56% tax free, which in the 32% tax bracket is equivalent to a 5.23% taxable yield.
California Treasurer Bill Lockyer expects to use the bond proceeds to fund some of the state’s huge backlog of infrastructure projects and to pay off higher-cost debt.
How safe are the bonds? California has the second-lowest credit rating of all the states, and the budget situation is dismal. But debt repayment is mandated by the state Constitution. Check out this recent post I wrote on the safety issue.
As for the muni bond market overall, the latest upheaval is partly related to new credit downgrades last week of major bond insurance companies including Ambac Financial Group, MBIA and Financial Guaranty Insurance Co. That has left some investors unable to properly value certain bonds insured by those firms, said Matt Fabian, senior analyst at Municipal Market Advisors in Westport, Conn.
The result: Many investors have stepped back from the muni market, period, he said.
Given that backdrop, "California did fairly well with its offering," Fabian said.
Here are the tax-free yields on the California bonds sold today, by maturity:
Year Yield
2009 1.75%
2010 2.70%
2011 3.10%
2012 3.37%
2013 3.56%
2014 3.74%
2015 3.92%
2016 4.05%
2017 4.18%
2018 4.33%
2019 4.45%
2020 4.55%
2021 4.70%
2022 4.76%
2023 4.80%
2024 4.87%
2025 4.92%
2026 4.97%
2027 5.02%
2028 5.05%
2029 5.09%
2030 5.13%
2031 5.19%
2034 5.24%
2036 5.28%
2038 5.30%
A few notes from around the markets today:
-- Can the Dow defend its lows? The blue-chip Dow industrials this morning briefly slid below their multiyear closing low of 11,740.15 reached on March 10, dropping as low as 11,725 after the latest bleak reports on consumer confidence and home prices. But the market then bounced higher. At about 10:30 a.m. PDT the Dow was up 35 points to 11,876.
 A new closing low for the Dow would reinforce the bears’ case that the spring upturn in the market was nothing but a sucker’s rally. Most other major market indexes, though, have more of a cushion between their current levels and their March lows. For more on what ails blue chips, in particular, see this post.
A new Dow low also could further complicate life for Federal Reserve policymakers, who meet on Wednesday and are virtually certain to leave their key short-term interest rate unchanged at 2%. The last thing Fed Chairman Ben S. Bernanke and peers need is another confidence-crushing event that could put more pressure on them to cut rates further -- while inflation pressures mount.
-- The state goes to the well. California today will set yields on its offering of $1.5 billion in general-obligation municipal bonds, the latest sale to raise money for the state's large backlog of infrastructure projects. Treasurer Bill Lockyer, as usual, gave small investors a chance to put in orders for the tax-free bonds ahead of institutional investors.
But the retail order period, Friday and Monday, didn’t bring in the level of orders the state saw at its bond sales earlier this year -- despite a rise in muni yields in recent weeks. Lockyer said small investors ordered $704 million in bonds, or 47% of the total offering. By contrast, the state got about $900 million in orders for its bond offering in early April. The state always pays its debts, but some investors still may be queasy about the projected $15-billion budget deficit for the new fiscal year.
-- Just leave it to Wall Street? Possible quote-of-the-day from the U.S. Senate hearing today on whether Congress should do something to kick investors and speculators out of commodity markets, or limit their presence, in an attempt to bring down prices of oil and other raw materials:
"Prohibiting investment opportunities for institutional market participants effectively substitutes the judgment of Congress for the judgment of trained financial investment professionals," said James Newsome, president of the New York Mercantile Exchange. "It would be premature to adopt a legislative solution for an unproven and unsubstantiated problem."
But let's not forget -- and I'm sure Congress won't -- that the judgment of "trained financial investment professionals" brought us the subprime mortgage debacle.
Photo: Fed Chairman Ben S. Bernanke
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
State Treasurer Bill Lockyer’s campaign to get a AAA-credit rating for California is gaining traction.
Moody’s Investors Service, one of the Big Three credit-rating firms, said Thursday it planned to begin rating municipal bonds the same way it rates corporate and foreign sovereign debt.
That could lift California’s debt rating, now fixed at A1 by Moody’s. The Golden State has the lowest credit rating of any state except for Louisiana.
Lockyer, other state treasurers and some in Congress have for months been jawboning the credit-rating firms to change the way they judge the risks of tax-free municipal bonds.
 Lockyer’s argument long has been that there is no risk that California could default on its debt because the state Constitution mandates repayment. Given that, he says, the state should get the top rating of AAA.
Moody’s and its rivals, Standard & Poor’s and Fitch Ratings, have used other criteria to grade muni bonds, including issuers’ ability to balance their budgets.
That’s what accounts for California’s low credit grade: The state has a history of busted budgets and borrowing to fund deficits. We’re back in that soup now, facing a projected deficit of at least $15 billion in the new fiscal year.
Despite criticism that it was caving in to political pressure, Moody’s said it would move its muni ratings to a "global scale," meaning on par with how it judges companies and foreign nations. It will take public comments on the proposed shift until June 30 and announce a timeline in July.
The credit-rating firms don’t have a lot of friends in high places nowadays, given the sterling grades they gave hundreds of billions of dollars’ worth of sub-prime mortgage debt that has since gone bad. So Lockyer struck at a time when the companies were vulnerable to criticism about their rating systems. But he says the muni rating regime has been patently unfair, dooming many issuers to less-than-top-level grades that then force them to pay high interest rates to borrow, or to buy private bond insurance.
Lockyer commended Moody’s on Thursday and said he would "work to ensure the system Moody’s adopts for taxpayer-backed bonds places primary emphasis on the risk of default."
"We do not oppose the use of other factors," he said. "But we strongly believe additional factors should have a clear, demonstrated relationship to the risk investors might not get paid."
It isn’t clear whether S&P and Fitch will follow Moody’s, which is far out front on this issue.
Whether a higher rating would save California much in interest costs remains to be seen. It’s no secret to most big investors that there’s no real risk of the state defaulting. But in markets, perception can count as much as reality, and the state’s ongoing budget woes don’t paint a glowing picture of California as a debtor.
In the long run, though, a AAA rating would help the state attract new investors, including more small investors and foreigners, said Matt Fabian, senior analyst at Municipal Market Advisors in Westport, Conn. Rating muni, corporate and foreign bonds on one scale "would make it an easier comparison for investors," he said.
And for investors who already own California bonds, any upgrade would be a gift, of course -- and certainly better than a move in the other direction.
Photo: State Treasurer Bill Lockyer. Jamie Rector/Associated Press
California taxpayers may be among the big winners in the U.S. Supreme Court’s decision on Monday not to upset the apple cart in the world of municipal-bond finance.
But some individual investors might well have liked to have had the cart overturned. It might have provided them with more diversification options for their muni portfolios.
The high court issued its much-awaited ruling in a Kentucky case that challenged the rights of states to exempt their own muni bonds from state income tax while taxing the interest generated by other states’ bonds.
The court voted 7 to 2 that the long-standing practice by the states doesn't violate the Constitution, so the decision maintains the status quo in the muni market. (For more on the ruling, and some background on the case, go here.)
 The upshot is that California and other high-tax states get to preserve their captive investor audiences: If you’re given a double tax exemption (federal and state) on a California muni bond, why would you buy a bond of another state that would be subject to California’s steep income tax?
The captive-audience factor helps California and its counties, cities and other local issuers finance government operations. Without that tax favoritism -- that is, if California issuers had to compete for individual investors’ attention with muni issuers across the nation -- California bonds might have to pay higher yields (same for the debt of New York, Massachusetts and other high-tax states).
That’s a headache California Treasurer Bill Lockyer didn’t need. Given the state’s low credit rating and deteriorating fiscal situation, "Taxpayers could ill afford to see any additional money go out the door" to pay bond interest costs, said Tom Dresslar, a spokesman for Lockyer.
The mutual fund industry also breathed a sigh of relief after the court’s decision. All those single-state muni bond funds would have lost their reason for being if the justices had decided otherwise. "This removes a cloud of uncertainty" over the single-state fund business, said John Miller, who heads the muni investing team at Nuveen Investments in Chicago.
Yes, but what of muni investors? True, an adverse decision could have disrupted the market just as yields have settled back after spiking in winter in a sell-off fueled by Wall Street’s credit crunch. Many muni investors like the market the way it usually is: uneventful.
Still, diversifying a muni portfolio could be to a California investor's advantage in the long run. One obvious danger faced by owners of the state's bonds is that a major earthquake could financially devastate the state or some municipalities, threatening their ability to pay their debts.
You can, of course, diversify on your own, and some people do. But that double-tax-exemption for in-state debt, now blessed by the Supreme Court, is a powerful incentive to remain a captive investor in California.
For the municipal bond market, no news is good news today.
The Supreme Court issued its long-awaited ruling in a case that challenged the rights of states to exempt their own muni bonds from state income tax while taxing the interest generated by other states' bonds. The court ruled 7 to 2 that the practice doesn't violate the Constitution, so the decision preserves the status quo in the muni market.
Read Bloomberg's report on the ruling here.
The case, brought by a couple of Kentucky investors in 2003, contended that the muni tax regime was unfair and protectionist because it in effect created a captive audience for a state's bonds.
The interest on most municipal bonds -- debt issued by states, counties, cities, school districts and other local government bodies -- is exempt from federal income tax. When a state also exempts its own bonds from its income tax, but taxes interest on other states' debt, investors in that state often have little reason to buy out-of-state muni securities.
That's particularly true for investors who live in high-tax states such as California.
If the court had ruled in favor of the Kentucky investors, every state could have faced one of two options: tax interest on all muni bonds, including a state's own issues, or exempt all from taxation. Either way, that could have been very expensive for muni issuers in California, and extremely disruptive to the $2.6-trillion muni market in general.
The Kentucky case didn't challenge the federal tax exemption on muni bonds.
Wall Street has been worried about another shoe dropping in the loss-ridden financial sector. Today it looks like one of the original dropped shoes is back for a replay.
Shares of bond insurance company Ambac Financial Group Inc. have plummeted to new lows after the firm said it lost $1.66 billion, or $11.69 a share, in the first quarter. That far exceeded analysts’ worst estimates.
Although a big part of the loss stemmed from "non-cash" accounting write-downs on insurance contracts tied to mortgage-backed bonds that have fallen in value, that isn't making investors feel any better. The stock was off 40% to $3.59 at about 10:30 a.m. PDT.
You know it's a bad situation when Ambac, once again, had to insist to investors today that it wouldn't file for bankruptcy protection.
This, after the company raised $1.5 billion by issuing new stock last month to shore up its capital.
Shares of rival MBIA Inc. are down $4.03, or 30%, to $9.25 today.
The bond insurers helped deepen the U.S. credit crunch last fall as they began to reel from losses on sub-prime-mortgage-backed bonds they had insured. That led to fears that the companies would be unable to make good on insurance on municipal bonds -- which had been their bread and butter before they jumped on the sub-prime bandwagon.
Posted April 23, 2008
More on regulators' probes into so-called auction-rate debt, which have caused misery for thousands of investors who have become trapped in the securities amid the credit crunch: Bloomberg News reports today that the Securities and Exchange Commission wants brokerages to hand over more details about how the bonds were pitched to investors.
"We are looking at representations made to investors when they purchased auction-rate securities," Lori Richards, head of the SEC’s Office of Compliance Inspections and Examinations, told Bloomberg.
The SEC’s inspections office sent letters to the biggest sellers of auction-rate debt this month seeking the names of customers who purchased the notes and the identities of brokers who sold them, Bloomberg reports.
On Thursday the North American Securities Administrators Assn. said nine states were coordinating their probes of the $330-billion auction-rate market. And New York Atty. Gen. Andrew Cuomo was reported to have subpoenaed 18 banks and brokerages about their involvement in the securities. For more on the states' efforts check out this earlier post.
Posted April 18, 2008
Good news for investors trapped in so-called auction-rate securities: State regulators are feeling your pain.
 The North American Securities Administrators Assn. today said regulators in Florida, Georgia, Illinois, Massachusetts, Missouri, New Hampshire, New Jersey, Texas and Washington were coordinating their probes of the $330-billion market. And late in the day New York Atty. Gen. Andrew Cuomo was reported to have subpoenaed 18 banks and brokerages about their involvement in the securities.
Auction-rate securities are a form of debt issued by many municipalities and closed-end mutual funds in recent years. They are, in effect, long-term bonds masquerading as short-term debt. The interest rate they pay typically is reset at weekly or monthly auctions.
Brokers often pitched the securities as equivalent to money market funds, but with higher yields. As the credit crunch worsened this year, however, many investors have pulled back from complex debt issues. As auction-rate issues have failed to attract new buyers at their weekly or monthly rate resets, most current owners of the securities have been told they’re stuck with them.
That has left thousands of investors unable to get their cash back, because brokerages have refused to buy the securities from their clients, and only a small number of municipal and fund issuers of the debt so far have been willing or able to retire the securities via refinancing. To say investors are infuriated is putting it mildly.
NASAA said the state probes centered on sales practices and supervisory issues related to auction-rate issues. "Our focus is to determine what conduct took place at the point of sale -- what was potentially misrepresented and omitted -- and our goal is securing for investors access to their cash as requested," said Karen Tyler, NASAA president and securities commissioner of North Dakota.
"If the product was represented to be a cash equivalent going in, it must be treated as a cash equivalent coming out," she said.
Photo: New York State Atty. Gen. Andrew Cuomo/Associated Press
California had great timing with its sale of $1.75 billion in general-obligation bonds this week. But that’s translating into lower interest returns than the buyers of the bonds might have hoped.
The state’s bond deal came to market amid a resurging investor appetite nationwide for the relatively high tax-free yields on municipal securities.
 That appetite was evident in the orders that individual investors placed for the California bonds: State Treasurer Bill Lockyer’s office said it got nearly $900 million in retail orders Tuesday and Wednesday.
At the start of the order period, the state figured it would be paying an annualized yield of 5.14% on the 30-year bonds in the deal. Instead, the final yield was 4.96% on that issue. That yield is exempt from federal and state income tax.
The final yields were set today, after institutional investors placed their orders. If retail investors didn’t like the final yields they were allowed to rescind their orders, and some did. That cut the final retail order tally to about $800 million, a Lockyer spokesman said.
Credit-market turmoil in February and March left many investors wary of muni bonds. That also produced spectacular bargains: When the state sold $1.75 billion in bonds in early March, it had to pay 5.4% on the 30-year issue in that deal.
Individual investors, smartly, were all over that bond sale. They put in orders for nearly 90% of the total issued.
So this time around, as yields have declined, individuals weren’t quite as enthused. But getting retail investors to take almost half the bonds still is a big achievement compared with what the state was used to getting in recent years.
The state’s bond offerings raise money for voter-approved infrastructure projects and to pay off higher-yielding debt. The securities are sold in maturities of one to 30 years. The next California general-obligation bond sale is likely to be in June.
A sampling of the final tax-free yields in this week’s deal: 3.33% on the five-year bond, 4.15% on the 10-year, 4.63% on the 17-year and 4.86% on the 25-year.
Photo: The Capitol in Sacramento. Robert Durell/Los Angeles Times
Lured by good, if not great, tax-free interest rates, individual investors today snapped up nearly half of California’s offering of $1.75 billion in municipal bonds.
Treasurer Bill Lockyer’s office said individuals, via brokerages, had put in orders for $824 million of the bonds as of 5 p.m. PDT.
That wasn’t as strong as the demand at the last such sale, in early March, but it was enough to spur Lockyer to again cut short the planned two-day retail order period for the securities. The state said it would take orders from small investors only through noon Wednesday instead of through 5 p.m. And a spokesman for Lockyer said new retail orders would be limited to bonds maturing in 2022 (a 14-year issue) and 2038 (a 30-year issue).
The final yields for all of the bonds in the deal will be set on Thursday, when institutional investors bid.
The state’s sale is one of its periodic bond offerings to finance voter-approved infrastructure projects or pay off higher-cost debt. The bonds, sold in maturities of one to 30 years, are general-obligation issues, meaning they’re backed by the state’s full faith and credit. The interest they pay is exempt from federal and state income tax for California residents.
Although the tax-free yields on muni issues are almost always attractive to high-income folks, even the less-than-well-heeled have found the bonds appealing this year, particularly compared with low-yielding U.S. Treasury issues. The 30-year bond in the current state offering, for example, is expected to pay an annualized yield about 5.05%. By contrast, the yield on 30-year Treasury bonds is about 4.37%. And Treasury interest is subject to federal income tax (but not state tax).
But muni yields have come down since early-March, and that has made them less lucrative. The 30-year bond in the March deal yielded 5.4%. In the March sale individual investors put in orders for nearly 90% of the $1.75 billion in bonds offered.
For more background on the state's sale and what has been happening in the muni bond market in recent months, see the links in this posting.
Update on the California tax-free-bond sale launched today: At noon Pacific time, the state said it already had retail orders for 43%, or $750 million, of the $1.75-billion offering of general-obligation bonds.
The state is taking individual-investor orders (through brokerages) until 5 p.m. The retail order period for the bonds is supposed to go through Wednesday, but Treasurer Bill Lockyer could shorten that if demand remains robust.
For the preview item I wrote on the bond sale, look below or go here.
California retail investors were breaking down the doors to get a piece of the state’s last big tax-free-bond deal, in early March.
They’re getting another chance to buy today and tomorrow: The state this morning launched an offering of $1.75 billion in general-obligation bonds, with securities maturing between one and 30 years out.
The yields on the bonds, however, look like they’ll be significantly lower than what the state paid at the sale in the first week of March. Bond dealers said this morning that the market’s expectations were for a 4.25% yield on the 10-year bonds, down from 4.58% at the last sale. The 30-year bond is expected to yield about 5.1%, down from 5.4% at the last sale.
The state will take retail orders today and tomorrow; the final yields will be set on Thursday, when institutional investors bid. To buy, you have to go through a broker. The state has a list of participating brokerages on its website, buycaliforniabonds.com.
Yields were sharply higher at the March bond sale because that deal followed a dramatic sell-off in municipal issues in general — a byproduct of the credit crunch. I explained what was happening then in this column.
The muni market has calmed significantly since then, which has helped pull yields down. Still, the interest rates remain attractive for many California investors. Because muni yields are exempt from federal and state income tax for California residents, a 4.25% tax-free yield is worth the same as a fully taxable yield of 6.16% for someone in the 31% federal and state marginal tax bracket. (That bracket begins at taxable income of $70,921 for a married couple filing jointly.)
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Tom Petruno
Tom Petruno has been chronicling financial markets' highs and lows since 1979, and has been the Times' financial columnist since 1990. He writes on markets, corporate finance and the economy, and how it all ties in to individual investors' portfolios.
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