California to launch $2-billion muni bond sale Tuesday

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California, still the state with the weakest credit rating in the Union, is hoping individual investors will see opportunity in trouble as Treasurer Bill Lockyer tries to sell $2 billion in tax-free general obligation bonds this week.

As he has in the past, Lockyer is spending money on an ad campaign to lure investors to the bonds. Strong demand from individuals would mean fewer bonds left for institutional investors such as mutual funds. If that means the big players have to compete more aggressively for the remainder of the deal the state might be able to pay a lower overall interest rate to borrow, saving taxpayers cash.

As I wrote in my column over the weekend, individual investors in California have long been heavy buyers of muni bonds of state and local governments. But I noted that as the state’s finances have deteriorated in recent years some wealth advisors have shifted a portion of clients’ muni portfolios into higher-quality out-of-state issues for diversification’s sake.

The new bonds Lockyer plans to sell (in various maturities from two years to 30 years) won’t help the state plug its $20-billion budget gap. Rather, the proceeds will be used to finance voter-approved infrastructure projects statewide.

The securities will be offered to individuals on Tuesday and Wednesday. Institutional investors will put in orders on Thursday, and that’s when the final yields on the bonds will be set.

The state sells its debt via brokerages, so you must have an account with a brokerage to place an order, although there are no upfront commission charges to buy. The minimum purchase is $5,000. Note that there’s no guarantee you’ll get bonds if orders are robust; brokers naturally are going to favor their best customers. See Lockyer’s Buy California Bonds website for more details on the offering.

Tax-free muni bond yields nationwide and in California have fallen in recent months, in part because individual-investor demand has remained healthy while the supply of new bonds has dwindled. Instead of issuing tax-free debt many states and local governments have been raising money via taxable Build America Bonds, which are extremely popular with institutional investors. . . .

Despite California’s fiscal misery, many high-income investors probably will find the tax-free yields on the state’s bonds too attractive to pass up. Case in point: If the seven-year bonds in the deal pay approximately what existing bonds of that maturity have been yielding in recent days, the annualized tax-free interest rate will be around 3.6%.

For a California couple in the 39.4% combined federal and state income tax bracket -- which starts at taxable income of about $209,000 -- a 3.6% yield exempt from federal and state income tax is the same as earning a fully taxable yield of about 5.9%.

Tax-free muni yields will be worth even more if Congress allows President Bush’s tax cuts to expire as planned on Jan. 1.

As for the safety of the state’s bonds amid the still-grim economy, debt holders’ payments are mandated by the California Constitution. Even so, to make investors feel better, Lockyer backed a bill the Legislature passed last week that gives state finance officials more flexibility in managing short-term cash flows -- the idea being to keep cash levels in the state’s coffers high enough to calm concerns that bond holders’ payments could be delayed by temporary money shortages.

Lockyer feared that, without that change in the law, the state’s credit rating might take another hit. After the legislation passed last week the three main bond-rating firms, Standard & Poor’s, Moody’s Investors Service and Fitch Ratings, all maintained their California ratings at the existing levels of A-minus, Baa1 and BBB, respectively. But the Golden State still looks like a pariah, relatively speaking: Most states are rated AA or higher.

-- Tom Petruno