Deficit-Struck California Outperforms Amid Debt-Sale Freeze: Muni Credit
Debt of California and its local governments, the biggest issuer of municipal bonds in the last seven years, is beating the broader tax-exempt market in 2011 amid a state borrowing freeze.
California securities produced an 8.6 percent tax-free return in 2011, according to the Standard & Poor’s/Investortools Municipal Bond Index, which includes interest income and price change. That’s more than the 7.5 percent for the overall $2.9 trillion municipal market. U.S. Treasuries have returned a taxable 8.3 percent this year, according to Bank of America Merrill Lynch indexes.
The combination of high demand and diminished supply has helped California post the best return this year of the 26 states for which S&P has performance data. California bonds beat the overall market last year after trailing the previous three, S&P indexes show.
“There’s a lot of demand for California paper, given that it tends to yield more than most,” said Kelly Wine, executive vice president of RH Investment Corp., a broker dealer in Encino, California, that will help underwrite a state general- obligation bond sale later this year. “Between issuances, we end up seeing more demand than we can supply.”
The state will offer $8 billion of debt this month in its first tax-exempt issues of 2011 as municipal borrowing this week and last is set to be the lowest for the period around Labor Day in seven years.
California has helped drive demand for the state’s debt this year by not selling any tax-backed bonds as Treasurer Bill Lockyer and Governor Jerry Brown dealt with what was a $26 billion budget deficit. Lockyer said he expects to offer less than 33 percent of the $27 billion of short- and long-term bonds he sold last year.
The state may need to add yield at the coming sale to attract investors, said Joe Gotelli, who manages $2.25 billion of California debt at American Century Investments. California debt yields about 1.31 percentage points more than top-rated municipal debt, compared with a peak yield spread this year of 1.47 percentage points in June, according to Bloomberg data.
“Bringing this size could disrupt some of the spreads,” Gotelli said in a telephone interview from Mountain View, California. “But in reality, there’s been so little supply year-to-date that a couple billion extra dollars in long-term issuance really isn’t going to rock the boat.”
Gotelli’s California Intermediate-Term Tax-Free Bond Fund beat 88 percent of its rivals during the five years through Sept. 2, with a 4.41 percent average annual return, according to data compiled by Bloomberg.
Total municipal borrowing this year has been $146.2 billion, Bloomberg data show, $109.4 billion less than the same period in 2010, when federally subsidized Build America Bonds encouraged sales.
California and its municipalities sold $59 billion of long- term bonds last year, according to Bloomberg data, more than New York’s $39 billion and Texas’s $34.8 billion.
This year, with the debt moratorium, California trails New York by $818.7 million after being the No. 1 seller among the three largest issuers each year since 2004, the data show.
Ten-year general obligations from California issuers yield 4.23 percent on average this year, or about 136 basis points more than top-rated 10-year general-obligation debt, according to Bloomberg Fair Value indexes. A basis point is one hundredth of a percentage point.
At A-, California has the lowest general-obligation credit rating of any state from S&P. Investors demand more yield from issuers with lower credit ratings, and higher yields spur demand when supply is low. For the year so far, California has outperformed AAA rated Maryland by 238 basis points, according to the S&P/Investortools index.
The stable outlooks from the rating companies will help California continue to outperform, said Tom Boylen, a municipal- bond trader at Performance Trust Capital Partners in Chicago.
“There may be a short-term window where it gets a smidge cheaper in step with the supply,” Boylen said in a telephone interview. “I don’t think it will have any long-term effects just because of that deal.”
California will sell $5.4 billion of revenue-anticipation notes Sept. 15 and as much as $2.6 billion of long-term debt Sept. 20. Lockyer will use the revenue notes to pay off a cash- flow loan he secured July 27 from Goldman Sachs Group Inc. (GS), Wells Fargo & Co. (WFC), six other banks and investors.
The treasurer took the loan anticipating a possible credit- market disruption as Congress debated raising the nation’s debt ceiling. Without the loan, the state was in danger of running out of money, as it did in 2009, when the controller issued $2.6 billion of IOUs amid a legislative budget impasse.
The new notes will go to market as yields on such debt have plunged along with Treasury rates. One-year tax-exempt note yields hovered at 0.31 percent last week, according to a Bond Buyer index, down from 0.51 percent a year earlier and 3.62 percent in 2007, before the recession. One- to three-year Treasury yields also fell in the last year, to a record-low 0.56 percent last week from 0.9 percent.
“Times are a little unusual right now,” said Wine of RH Investment. “A little widening of the spreads once we get the new deal in the market” can be expected, she said.
California sold $10 billion of RANs at the end of November. The sale included $2.25 billion of notes that came due in May with a yield of 1.5 percent and $7.75 billion that matured in June at 1.75 percent.
The May notes yielded 98 basis points more than top-rated one-year debt at the time and the June notes yielded 123 basis points more, Municipal Market Advisors data show.
Following is a description of a pending sale of municipal debt:
NEW YORK STATE THRUWAY AUTHORITY, which oversees a 570-mile toll road system, will sell as soon as tomorrow $350 million of personal-income tax revenue bonds to finance highway and bridge projects. The bonds are rated AAA, Standard & Poor’s highest grade. Siebert Brandford Shank & Co. LLC will lead banks on the deal. (Added Sept. 1)
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