California was forced to boost interest rates on a sale of $1.8 billion in tax-free muni bonds Wednesday, as institutional investors demanded higher yields to close the deal.
The state set a yield of 3.70% on the 10-year bonds in the offering, up from a preliminary estimate of 3.51% on Monday. The five-year bonds in the sale will pay a yield of 2.28%, up from an initial estimate of 2.10%. The bonds were sold in maturities of three to 30 years, with the longest-term issue yielding 5.03%.
Interest on the bonds is exempt from state and federal income taxes for California residents. The proceeds from the sale will fund voter-approved infrastructure projects.
Treasurer Bill Lockyer had to pay higher yields after the bonds got a lukewarm reception from individual investors Monday and Tuesday. Those investors put in orders for $387 million of the debt, or about 21.5% of the total.
By contrast, individual investors ordered almost 28% of the $2.37-billion bond offering the state sold Sept. 20. And at the sale before that, in November, individuals sought nearly 80% of the deal -- when yields were substantially higher. The 10-year bonds in that offering paid 4.23%.
The relatively low demand from individuals this time around meant that institutional investors, such as mutual funds, had more leverage to push for higher returns when the state took their orders Wednesday. That will benefit individuals who ordered the bonds Monday and Tuesday, because all buyers get the same final yields.
It also means taxpayers will foot a bigger bill for interest costs than Lockyer had hoped.
Some muni bond market analysts say individual investors balked at the offering because they’re unhappy with the relatively low interest rates on tax-free bonds in general, even though yields have risen over the last few weeks.
“Retail investors are deeply ambivalent about bonds at these yields,” said Matt Fabian, an analyst at research firm Municipal Market Advisors in Concord, Mass.
Interest rates on high-quality bonds have dropped across the board this year as the Federal Reserve has tried to put more downward pressure on all rates to help the economy.
The tax exemption on muni bonds means their returns are more attractive than yields on many taxable securities. A five-year U.S. T-note pays just 1.04%, and that interest is federally taxable.
Still, many investors are put off by the low nominal returns on munis compared with what they remember in recent years, said Marilyn Cohen, head of money management firm Envision Capital Management in Los Angeles.
“Given the market we confronted, we’re satisfied with the results,” said Tom Dresslar, a spokesman for Lockyer in Sacramento. “We’re confident we got the best deal possible for taxpayers.”
Besides the $1.8 billion in tax-free bonds, the state also sold $205 million in shorter-term taxable bonds Wednesday.
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-- Tom Petruno
Follow me on Twitter: Twitter.com/tpetruno
Photo credit: Makaristos