California cuts bond sale over prison legal battle

California today pared back its last big tax-free bond sale of 2009, citing legal questions about funding for a prison project.

Treasurer Bill Lockyer sold $743 million in lease revenue bonds for the state Public Works Board instead of the $1.34 billion that had been planned.

The deal was slashed in size because funding was dropped for a new death-row-inmate complex at San Quentin prison. The fate of that complex is in limbo because of an ongoing legal battle between the Legislature and Gov. Arnold Schwarzenegger over certain budget items that he has vetoed.

"Legal questions arose Wednesday about whether the San Quentin facility could be funded with the bonds," said Tom Dresslar, Lockyer’s spokesman. "The state did not have enough time to address those issues and decided to drop the project from the sale."

The smaller deal size allowed the state to slightly trim the interest rates on some of the bonds. For example, the Series I bonds maturing in 10 years will pay a tax-free annualized yield of 5.10%, a sliver less than the 5.12% the state had preliminarily set.

It helped the state that yield-hungry individual investors put in orders for $447 million of the bonds. That was 61% of the final total sold. A hefty number of individual-investor orders gives the state more leeway in negotiating the final interest rates on its bonds with institutional investors.

The state now has borrowed more than $21 billion since late September via short- and long-term debt for budget-related reasons and to finance voter-approved infrastructure projects. That supply glut has helped to push up tax-free muni bond yields across the board as investors have demanded higher returns to absorb all of the debt.

Fundamentally, tax-free munis remain appealing compared with taxable bonds, as I noted in this earlier post. The jump in yields over the last six weeks should reinforce that appeal.

The state’s borrowing binge is nearly over for the year, which could put downward pressure on California muni yields in the near term.  Lockyer has just one more sale of tax-free bonds planned for 2009: a $200-million issue for the University of California on Dec. 3.

-- Tom Petruno

Photo credit: Ben Margot / Associated Press

Despite fiscal woes, muni bonds' appeal stays strong

The good news in the sell-off that has clipped California tax-free municipal bond prices over the last six weeks is that the market now should be harder to shock.

So for muni investors, the report Wednesday that Sacramento already may be facing a $21-billion budget gap over the current and next fiscal years was more a firecracker than a bomb.

After rallying sharply in August and September, the California muni market has given back some of those gains since early October. Amid a flood of new bond sales by the state investors have demanded higher yields, which in turn has pushed prices of existing bonds down.

California is back in the market this week with a $1.34-billion revenue bond offering from the Public Works Board to finance infrastructure projects. Yields on those bonds will be set today.

All in all, though, the damage to the market from the supply glut has been relatively modest, at least for muni mutual fund investors who have the benefit of wide diversification. Case in point: The per-share net asset value of the Franklin California Tax-Free Income fund, which holds $14.2 billion of state and local debt, was $6.90 on Wednesday, a drop of 4% from the 52-week high of $7.19 on Oct. 5.

That’s unfortunate for anyone who bought near the high, but year-to-date the fund’s total return (share price gain plus interest earned) still is a hefty 15.6%. And that’s even better than it looks, given that the interest earned is exempt from state and federal income tax.

The muni market nationwide has been suffering a bout of indigestion since September, driving yields higher. But nationally and in California the market has been stabilizing over the last week or so.

Despite the dire fiscal outlooks for many state and local governments, there are three main reasons to believe that the muni market is unlikely to fall off a cliff from here and wipe out all of its recovery from the worst of the credit crunch:

--- Big investors just don’t buy the idea that actual defaults by muni issuers in 2010 will match the doomsday predictions that are out there.

"There is going to be a lot of ‘headline’ risk in the market over the next 12 to 18 months," said Chris Sperry, co-manager of the Franklin California fund. But local governments of any size know, he said, that the decision to default would make it impossible to get the basic credit they need to function. The market clearly believes that the vast majority of politicians will get out the cleaver and hack expenses further, not bond payments.

--- Muni yields still are historically high versus yields on taxable bonds. A 10-year California state general obligation bond now yields about 4.55% tax-free, compared with 3.36% for a 10-year U.S. Treasury note that is federally taxable. Muni bond yields normally are below Treasury yields.

"In order for muni yields to get a whole lot [higher] you’re going to have to see the Treasury market sell off," said John Carbone, manager of the Vanguard California Long-Term Tax-Exempt bond fund. That could happen, of course, but it probably would require the backdrop of a robust economic recovery or an inflation surge -- neither of which seems likely in the near term.

--- Many muni investors figure that tax rates at the federal, state and local levels can only go up as governments struggle to close deficits. That would boost munis’ appeal for yield-hungry investors. "Munis are going to become more attractive from a pure income standpoint," Sperry said.

Yes, he’s talking his book. But raise your hand if you think taxes are more likely to go down than up.

-- Tom Petruno

Frequent borrower California is back with another bond sale

California, which has borrowed $16.4 billion via short- and long-term bonds since Sept. 23, this week comes back to the well once more despite the jump in market interest rates over the last month.

The state plans to borrow $2.25 billion by selling long-term general obligation bonds in the next two days, mostly aiming at institutional investors. It’s expected to be the last general-obligation bond sale this year.

The debt will be issued in three parts:

--- On Tuesday, the state’s brokerage underwriters will take orders from individuals for $100 million of 25-year bonds. The state has set a preliminary tax-free annualized yield of 5.5% on the securities.

--- On Wednesday, institutional investors will be offered what’s left of the 25-year bonds plus a total of $1.4 billion of tax-free securities maturing in either 26 or 30 years. Longer-term municipal bonds typically are purchased by big investors; individuals usually prefer to stick with shorter-term securities.

--- Unexpectedly, Treasurer Bill Lockyer also scheduled for Tuesday a sale of $750 million of taxable bonds under the so-called Build America Bonds program. Lockyer spokesman Tom Dresslar said the 30-year offering was spurred by an "inquiry" from an unnamed investor. Other institutional investors will be invited to join in the bidding for the bonds, he said.

Build America Bonds are subsidized by the federal government, which commits to making direct payments to state and local issuers to offset 35% of their interest cost on the bonds.

California sold $1.75 billion of 30-year Build America Bonds at a taxable yield of 7.23% on Oct. 8. The investor behind the "inquiry" about another such deal may be figuring to get at least that level of yield.

This week’s debt offerings will help Lockyer whittle down the backlog of bonds California voters have approved for infrastructure projects such as schools and water facilities in recent years. The backlog, now about $60 billion, also was reduced with the sale of $4.14 billion of general obligation bonds on Oct. 8.

But the lion’s share of the state’s recent $16.4-billion in borrowing isn’t funding infrastructure projects. The $8.8 billion of short-term debt issued on Sept. 23, for example, provided cash for state operations until tax revenue rolls in later in this fiscal year.

A sale of $3.5 billion of bonds last week refinanced a portion of the state’s so-called economic recovery bonds, first issued in 2004 to plug that year’s accumulated budget deficit.

-- Tom Petruno

Photo: California Treasurer Bill Lockyer

Investors turn out for California muni bond sale -- for a price

California wrapped up a sale of $3.5-billion in tax-free municipal bonds on Thursday, and was able to trim yields slightly from initial expectations as investors bid aggressively for the debt.

Still, taxpayers will foot significantly higher interest costs than they did on the state’s last general-obligation bond offering, earlier this month.

Muni bond yields nationwide tumbled from July through September. But yields got so low by late September that investors suddenly went on a buyer’s strike. As a spate of new bond offerings hit the market early in October the issuers were forced either to jack up yields or pare their deals.

California got caught in that market push-back on Oct. 8 as it tried to sell $4.5 billion in bonds, including $1.3 billion in tax-free issues. The state had to boost yields to move the bonds.

In this week’s sale -- a refinancing of the state’s so-called economic recovery bonds, first issued in 2004 to plug that year’s accumulated budget deficit -- Treasurer Bill Lockyer had to agree to even higher yields than the state paid on the Oct. 8 deal.

For example, the 13-year bond in this week’s deal will pay an annualized tax-free yield of 4.85%, compared with the 4.47% yield on the 13-year issue in the previous bond sale. Higher interest rates mean servicing the debt takes a bigger chunk of the state budget.

But it could have been worse: Lockyer said the healthy investor demand, particularly from individuals, allowed the state to trim yields from the initial estimates on Tuesday. The state had expected to pay as much as 5% on the 13-year bond, for instance.

The state got $2.49 billion in orders from individual investors for this week’s $3.5-billion sale. Institutional investors bought what individuals didn’t take. Interest earned on the bonds is exempt from state and federal income taxes for California residents.

The state will be back in the market next week with a sale of $1.5 billion in tax-free bonds to finance infrastructure projects. Those bonds are expected to be sold only in long-term maturities. The shortest-term bond in that deal may be for 23 years.

Here are the final tax-free annualized yields on this week’s $3.5-billion bond sale:

Maturity    Yield

2013............2.48%

2014............3.01%

2015............3.52%

2016............3.93%

2017............4.17%

2018............4.40%

2019............4.54%

2020............4.65%

2021............4.69%

2022............4.85%

-- Tom Petruno

With yields up, California muni bond sale sees strong demand

The steep rebound in California municipal bond yields since the start of the month is bringing individual investors back to the market in a big way.

The state’s latest bond sale -- an offering of $3.5 billion in tax-free "economic recovery bonds" -- attracted $1.7 billion in orders from individual buyers by midday today, according to Treasurer Bill Lockyer’s office.

That’s far better than the state fared earlier this month, when it offered $1.3 billion of tax-free general-obligation bonds for sale and got just $428 million in individual-investor orders over two days.

The difference this time: significantly higher yields. For example, the preliminary annualized yield offered on the 13-year bond in this week’s deal is 5%, compared with the 4.47% the state paid on a 13-year bond in the sale Oct. 8.

Interest on the bonds is exempt from state and federal income tax for California residents.

"At these [yields] retail investors are back in," said Parker Colvin, a bond trader at Stone & Youngberg in San Francisco.

The so-called economic recovery bonds for sale this week will refinance previously issued ERBs. That was the debt that voters authorized in 2004 to bail the state out of that year’s budget mess.

The ERBs are backed not only by the state’s full faith and credit, like all general-obligation bonds, but also by a dedicated portion of sales tax revenue. Because of the specific tax backing, the bonds have slightly higher credit ratings than the state’s general-obligation bond ratings.

Standard & Poor’s, for example, rates the new ERBs "A-plus," compared with its "A" rating on the state’s general-obligation debt.

The state’s brokerage underwriters are taking orders for the bonds from individual investors today and Wednesday, and will take institutional orders Thursday. That’s when the final yields will be set.

Based on the demand so far, the state could end up paying lower yields than the preliminary rates it has quoted to investors. I’m hearing that the bonds maturing between 2013 and 2019 already are sold out. That would leave just the 13-year issue. [UPDATE at 4:30 p.m.: The state said it still had bonds to sell in the 2019 and 2022 maturities.]

California will be back in the market next week with a sale of $1.5 billion in general-obligation bonds to finance infrastructure projects, but those bonds are expected to be sold only in long-term maturities. The shortest-term bond in that deal may be for 23 years.

Typically, individual investors are reluctant to buy bonds maturing that far out. Those bonds usually are purchased by big investors such as mutual funds.

Here are the preliminary tax-free yields that were quoted today on the ERB deal (again, note that the final yields could be lower):

Maturity    Yield

2013.........2.55%

2014.........3.08%

2015.........3.59%

2016.........4.00%

2017.........4.30%

2019.........4.65%

2022.........5.00%

-- Tom Petruno

Investors force California to boost yields in big bond sale as demand wanes

California suffered a painful snub by investors Thursday, as the state’s attempt to sell $4.5 billion in longer-term general obligation bonds failed to attract enough demand to raise the full amount.

After boosting interest rates on a chunk of the debt, the state reduced the total size of the deal by 8%, to $4.14 billion, according to Treasurer Bill Lockyer’s office.

The debt, split among taxable and tax-free bonds, will finance voter-approved infrastructure projects.

Municipal bond analysts and investors said California was, in part, a victim of circumstance: The bond market overall -- including muni, corporate and U.S. government issues -- finally hit a wall last week after months of ravenous investor and trader demand that had pushed yields sharply lower.

Depressed yields finally led to a buyer’s strike, which quickly drove "momentum" traders out of the muni market, analysts said.

Suddenly, "People are punting bonds," said Matt Fabian, senior analyst at research firm Municipal Market Advisors in Westport, Conn.

On Thursday, even the U.S. Treasury market suffered a bout of indigestion as demand at the Treasury’s sale of $12 billion in new 30-year bonds was weaker than expected. The yield on existing 30-year T-bonds rose to 4.09% from 3.99% on Wednesday.

With investors insisting on higher yields on bonds in general before they’d buy, California was bound to be squeezed, analysts said. That also gave some investors an excuse to focus on the state’s still-troubled fiscal situation, which has left California with the lowest credit rating in the Union.

Tom Dresslar, a spokesman for Lockyer, acknowledged that the state’s weak credit rating "didn’t help" the bond sale results.

What’s more, institutional investors knew they could push the state for higher yields after bond orders from individual investors came in well below expectations.

Lockyer invited individuals to put in orders Tuesday and Wednesday. But their interest was muted: Of the $1.3 billion in tax-free bonds offered for sale, individuals ordered just 33%, or $428 million.

By contrast, when California offered $4 billion in tax-free bonds for sale in March, individuals quickly grabbed 75% of them.

The lure in March was that interest rates were much higher. The state paid an annualized 5.85% yield on the 20-year tax-free bond sold in March, for example. In this week’s offering, individual investors were offered a preliminary yield of 4.63% on the 20-year tax-free issue.

But the relative dearth of demand this time around forced the state to raise final yields across the board. The 20-year tax-free bond will pay 5%. The seven-year issue in the deal will pay 3.37%, up from the 3.1% initially offered.

The state was able to sell all $1.3 billion of tax-free debt it had planned. It also sold $1.75 billion in 30-year federally subsidized Build America Bonds at a taxable yield of 7.23%. (After the subsidy, the net rate paid by the state will be 4.70%.)

The state cut back on two other taxable issues it had hoped to sell, abandoning a 15-year issue entirely and reducing a four-year issue to $140 million from $250 million.

Although California had to shell out higher interest rates than it had hoped -- a bill to be footed by taxpayers -- Dresslar noted that rates still were well below what the state paid in the spring bond sale.

Here are the final yields that individual and institutional investors will be paid on the tax-free bonds (interest is exempt from state and federal income tax):

Maturity    Yield

2015.........2.95%

2016.........3.37%

2017.........3.70%

2018.........3.93%

2020.........4.28%

2021.........4.39%

2022.........4.47%

2025.........4.69%

2029.........5.00%

-- Tom Petruno

Investors balk at low yields in California bond sale

California came up short trying to sell longer-term municipal bonds to individual investors this week, in the first such sale since last spring.

The steep decline in market yields on muni bonds since July has left many investors unwilling to lock up their money in new bonds, traders said. That sentiment began to build last week, which turned out to be unfortunate timing for the state.

California, which is offering $1.3 billion in tax-free general obligation bonds to finance voter-approved infrastructure projects, said it took in orders for $428 million, or 33% of the total, on Tuesday and Wednesday. That wrapped up the early-bird order period the state always grants individual investors to give them a shot at buying bonds ahead of institutional investors.

After a disappointing first day of orders on Tuesday, the brokerage syndicate handling the bond sale for Treasurer Bill Lockyer raised interest rates modestly to try to attract more buyers. But orders remained at relatively low levels on Wednesday.

The slack demand contrasts with investors’ voracious appetite for the state’s last sale of longer-term tax-free bonds, in March. On the first day of that deal individual investors grabbed 75% of the $4 billion in bonds offered.

Bond yields were much higher then. The state paid an annualized tax-free yield of 5.85% on the 20-year bond in that deal. This time around, investors were tentatively offered 4.66% on the 20-year bond. (See this post for the preliminary yields on various bond maturities in the deal, but add about 0.03 points to each to account for the bump up in yields on Wednesday.)

Long-term interest rates in general have tumbled in recent months as more investors have shifted cash into bonds, often from money market accounts that pay virtually nothing.

But the market has come so far so fast that many individual investors no longer find muni yields attractive, said Brad Thiel, head of muni bond underwriting at brokerage Wedbush Morgan Securities.

Although California has the lowest credit rating among the states, "I don’t think people are pulling back because of the credit," Thiel said. "It’s the yield."

With a relatively small book of orders from individual investors, the state now will have to rely on institutional investors, such as mutual funds, to buy the rest of the tax-free bonds on Thursday. If they balk Lockyer might have to trim the size of the deal.

The state is hoping to raise $4.5 billion in all this week for infrastructure financing, including via a large chunk of federally subsidized, long-term Build America Bonds. Demand from big investors for those bonds is expected to be strong.

-- Tom Petruno

Photo: The Capitol in Sacramento. Credit: Los Angeles Times

California muni bond sale sees weak initial orders

California’s infrastructure-bond sale this week isn’t off to a strong start -- a sign many investors are unimpressed with municipal bonds after the latest steep drop in market yields.

I noted in this post that the state’s first sale of longer-term general obligation bonds since spring would be a big test of investor demand in the wake the muni market’s hot rally since July.

The brokerages handling the deal for the state took orders from individual investors beginning on Tuesday. Through the end of the day the state had orders worth $361 million for the total of $1.3 billion in longer-term tax-free bonds to be sold, according to Treasurer Bill Lockyer’s office.

So just 28% of the deal was spoken for. By contrast, when the state offered $4 billion in tax-free bonds for sale in March -- when bond yields were much higher -- individual investors grabbed 75% of the deal on the first day of orders.

Demand for $250 million of taxable munis California is selling this week to individual investors also is unimpressive: The state had orders for 25% of that deal on the first selling day.

The individual-investor order period will continue today. Institutional investors will put in bids on Thursday, and that’s when the final yields will be set. Depending on final demand, the yields could be higher or lower than the preliminary estimates shown below.

The state is hoping to raise $4.5 billion in all, including via a large chunk of federally subsidized Build America Bonds it’s expecting to sell to institutional investors on Thursday.

Here are the preliminary yields the state’s brokerages were quoting to investors on Tuesday on the tax-free bonds (interest is exempt from state and federal income tax):

Maturity    Yield

2015.........2.87%

2016.........3.10%

2017.........3.42%

2018.........3.64%

2020.........3.93%

2021.........4.04%

2022.........4.13%

2025.........4.38%

2026.........4.45%

2027.........4.51%

2028.........4.56%

2029.........4.63%

-- Tom Petruno

California to test bond buyers' hunger with $4.5-billion debt deal

Are California municipal bond investors ready to say no mas to lower yields?

We may find out this week, as state Treasurer Bill Lockyer offers $4.5 billion of voter-approved general obligation bonds for sale beginning on Tuesday. It's the state's first long-term debt offering since April, and comes just two weeks after Lockyer successfully sold $8.8 billion in short-term notes.

The California muni market has been starved for supply over the last two months, with the result that market yields on long-term tax-free bonds have continued to edge lower nearly every week -- because investors have in effect been fighting over what little is available.

This has been a national story with muni bonds and with fixed-income securities in general: Long-term yields have plunged since early August as investors have rushed to lock in returns, in part reflecting doubts about the economic recovery.

The annualized tax-free yield on 10-year California general obligation bonds was about 3.5% on Friday, far below the 5.25% yield investors could have gotten in late June.

And get this: The yield on the Bond Buyer newspaper's yield index of 20-year muni bonds nationwide slid last week to its lowest level since 1967, dropping to 3.94%, according to Bloomberg News.

Joe Lee, a muni trader at bond dealer De La Rosa & Co. in Los Angeles, said yields on California munis have dropped to levels that finally have made some potential buyers balk. "People think the market has run too fast here," he said.

California continues to have the lowest credit ratings of any state ("A" from Standard & Poor's and "Baa1" from Moody's Investors Service) because of its still-dicey budget outlook.

But thanks to federal assistance, Lockyer and other muni issuers this year have new borrowing flexibility that may work to keep yields depressed.

Though California will borrow $4.5 billion in all, the tax-free bond portion of the deal -- the traditional muni securities that individual investors want -- may total as little as $1.3 billion. The rest of the offering will be in the form of taxable bonds, including up to $2 billion of so-called Build America Bonds.

Under the Build America program, state and local governments borrowing to fund infrastructure projects can issue taxable debt that is subsidized by the federal government. That saves the borrowers on net interest costs, and provides them with new sources of investment demand: pension funds, life insurance companies and others that generally don't buy tax-free bonds.

For traditional muni investors, however, it all means a much more limited supply of tax-free bonds.

When the Los Angeles Unified School District sold about $2 billion of bonds last week to finance building and renovation projects, taxable Build America bonds comprised $1.37 billion of the deal, or more than two-thirds of the total sold.

Individual investors who are interested in the state's bond offering this week can put in orders on Tuesday and Wednesday. (You must order via a brokerage, and the minimum order is $5,000. For more information, go to Lockyer's website, buycaliforniabonds.com.)

The tax-free bonds (exempt from state and federal income tax) will be split among maturities ranging from one year to 30 years. As of Friday, here's what the approximate market yields were on existing California munis: two-year, 1.2%; five-year, 2.3%; 10-year, 3.5%; 20-year, 4.4%; 30-year, 4.95%.

But there's no way to know in advance whether the state will end up paying more, or less, than those recent yields. Individual investors are at the mercy of institutional investors such as mutual funds, which will submit their bond orders on Thursday. That's when the deal will be priced and the final yields will be set.

If individual buyers don't like the final yields they can cancel their orders at that point.

So the question is whether big investors, in particular, are ready to draw a line in the sand on California muni yields -- or whether fear of missing out will again trump concern that the bond market rally of the last two months has become overdone.

-- Tom Petruno

 

As muni bond yields keep falling, California sets $5-billion debt sale for October

California, which had no trouble selling $8.8 billion in short-term debt this week, next will test investors’ appetite for longer-term bonds.

The state plans to sell general obligation bonds the week of Oct. 5 to raise money for voter-approved infrastructure projects. The dollar volume hasn’t yet been set in stone, but the deal could total about $5 billion in bonds in maturities ranging from one to 30 years, a spokesman for Treasurer Bill Lockyer said.

Investors’ attitude toward California has taken a 180-degree turn since early July, when the Legislature and Gov. Arnold Schwarzenegger were battling over how to close a $24-billion budget gap (which they did, with some spending cuts and plenty of smoke and mirrors).

Concern over the state’s horrid fiscal health had helped drive up market yields on the state’s bonds in June. Back then, you could have bought a 10-year general obligation bond paying an annualized tax-free yield of 5.25%.

But those yields didn’t last, as investors quickly found them too attractive to resist, despite the state’s lousy credit rating. The California muni market began to rally in mid-July as buyers poured in -- driving bond prices up and yields down -- and that has pretty much been the story since.

On Thursday, bond dealer Stone & Youngberg in San Francisco was quoting a market yield of about 3.6% on 10-year California general obligation bonds.

Five-year California bonds now are paying about 2.4%, down from 4% at the end of June.

California has benefited in part from the across-the-board drop in long-term interest rates since July, as some investors fed up with near-zero yields on short-term accounts have shifted cash to longer-term government, corporate and muni bonds.

What’s more, there has been relatively little in new tax-free muni bond issuance in the last two months, so demand has easily outstripped supply.

Even when they have sold debt, many states, cities and other muni borrowers in recent months have relied heavily on taxable, rather than tax-free bonds. Under the Obama administration’s Build America Bonds program, state and local governments can issue taxable debt that is subsidized by the federal government.

That saves the borrowers on net interest costs, but it has contributed to the dearth of supply of tax-free bonds -- and left traditional muni bond investors fighting over whatever comes to market, as I noted in this post on the University of California system's bond sale last month.

The state’s planned general-obligation bond sale next month also will include Build America Bonds, but the amount hasn’t been decided, Lockyer’s spokesman said.

From the viewpoint of potential bond buyers, the best thing that could happen would be a sell-off in the California muni market leading up to the October bond sale, thereby pushing yields up.

But that would probably require a sell-off in the bond market overall. And so far, many yield-needy investors just aren’t in the mood to give up their bonds.

-- Tom Petruno