Investors balk at low yields in California bond sale

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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