Oct. 26 (Bloomberg) -- The state of California, returning to the bond market for the third time in a month, may pay yields of less than 5 percent this week to sell revenue bonds backed by sales taxes, lower than when it borrowed last week.

The most populous U.S. state, whose general pledge to repay debt carries the lowest credit rankings among its peers, is refinancing $3 billion in tax-exempt bonds issued in 2004 and 2008 to patch budget deficits. An 11 percent annual drop in sales-tax collections through June led to this deal, intended to smooth out repayment for the next 14 years.

California sold Public Works Board bonds last week rated below its general obligation, or G.O., debt and set to mature in 2022 at a yield of 5.33 percent. This week’s so-called economic recovery bonds may yield about 0.5 percentage point less, said David Blair, an analyst for Pacific Investment Management Co.

“There may be some buyers who are full of the G.O. name, but they could potentially buy this because of the better credit,” Blair, whose firm manages about $20 billion in municipals in Newport Beach, California, said in an interview.

The economic recovery bonds earned ratings of A+ from Standard & Poor’s, A1 from Moody’s Investors Service and A from Fitch Ratings. General obligation bonds from California are rated one level lower, at A by S&P, and three grades lower, at Baa1 by Moody’s and BBB by Fitch.

California is facing resurgent fiscal strains brought on by the worst recession since World War II. Since February, Governor Arnold Schwarzenegger and lawmakers have cut $32 billion from spending, raised taxes by $12.5 billion and covered $6 billion more with accounting maneuvers. State officials predict a total of $38 billion in deficits in the next three fiscal years.

Higher Than Other As

The state’s yields this week will probably still be higher than other A rated municipal bonds, Blair said.

“They’re going to have to price it a little cheap to that because of the size and the state’s economic issues,” he said.

More than three dozen underwriting firms led by Barclays Plc and Citigroup Inc. will market the California securities to individual investors Oct. 27-28, with final pricing Oct. 29, when institutions such as mutual funds will be able to buy.

Including the California issue, states, municipalities and nonprofit groups across the U.S. plan to sell more than $10 billion in fixed-rate bonds for the third time in the past four weeks, according to data compiled by Bloomberg.

Top-rated general obligation bonds due in 10 years were little changed today, with a median yield of 3.18 percent, according to a survey by Municipal Market Advisors of Concord, Massachusetts. The daily gauge had fallen to 2.95 percent on Oct. 1, the lowest in a least a decade.

‘A Little Easier’

“With yields going higher and retracing the declines we saw from the rally over the last several months, that’s made it a little easier to get deals done,” Blair said.

Finance officials said they hoped to attract retail demand for higher-rated California bonds due in less than 15 years.

“We are anticipating that, because of where we are going to be in terms of maturities, that this should be pretty well designed for retail business,” Tom Dresslar, a spokesman for Treasurer Bill Lockyer, said in an interview last week.

The state sold $4.14 billion of taxable and tax-exempt general obligation bonds on Oct. 8 after shrinking the size of the deal by 8 percent and raising yields to increase demand.

Its next tax-exempt general obligation debt sale is scheduled for the first week of November, with a total of $1.5 billion, Bloomberg data show. The deal will fund some public works voters approved in recent years.

To contact the reporters on this story: Jeremy R. Cooke in New York at jcooke8@bloomberg.net; William Selway in San Francisco at wselway@bloomberg.net

Last Updated: October 26, 2009 15:45 EDT