California Luring Most Cash Defies Bankruptcy Wave: Muni Credit

California's Governor Jerry Brown
California's Governor Jerry Brown signed a second straight on-time budget in June. Photographer: Ken James/Bloomberg

California municipal funds are garnering the most demand since 2007, helping fuel the biggest rally in the state’s debt since May and allaying concern that bankruptcies would curb the appetite of individual investors.

With local yields close to the lowest since the 1960s, investors seeking tax-free income are willing to take the added risk of debt from Standard & Poor’s lowest-rated U.S. state. Bond funds focusing on California issuers have added assets for 18 straight weeks, the longest streak since 2007, according to Lipper US Fund Flows data.

The funds increased even as three municipalities in the past six weeks from the most-populous state decided to file for bankruptcy protection, including San Bernardino and Stockton, a city east of San Francisco that is trying to set a precedent by imposing losses on bondholders.

“Those names have not been large enough to rattle investors even at generational-low yields,” said Marilyn Cohen, who oversees $195 million of munis as president and chief executive officer of Los Angeles-based Envision Capital Management. “The appetite is voracious.”

Buyers are more concerned with pending tax increases than recent bankruptcies, she said. Governor Jerry Brown, 74, signed a second straight on-time budget in June. The plan relies on voters in November approving $8.5 billion of temporary increases in sales and income taxes for the fiscal year that began July 1.

45 Years

Investors demand about 0.94 percentage point of extra yield to hold debt of California issuers, Bloomberg Fair Value data show. The yield gap, down from a six-month high of 1.06 percentage point two weeks ago, has narrowed the most since May.

Munis have joined a fixed-income rally led by Treasuries as investors seek shelter from Europe’s debt crisis and signs of a slowing global economy. Twenty-year general-obligation yields fell to 3.61 percent last week, according to a Bond Buyer index, close to a 45-year low set in January.

Tax-exempt debt declined across most maturities yesterday, with 10-year securities posting their biggest loss since mid-May, Bloomberg Valuation data show. Yields on AAA bonds due in 2022 rose about 0.04 percentage point to 1.66 percent, after last week touching 1.63 percent, the lowest since at least January 2009.

With tax increases looming while yields remain depressed, flows into California funds may persist, said Michael Pietronico, who handles about $770 million of munis as chief executive officer of Miller Tabak Asset Management in New York.

“Given that yields are so low, anything an investor can do to enhance return they’re doing,” he said.

Scarcity Effect

Individual investors have added $676 million to California bond funds since the streak of asset increases began in March, according to Lipper.

California debt has also benefited from relative scarcity. As part of steps to trim the state’s deficit, Brown cut issuance of general-obligation borrowing to $11.5 billion in 2011 and 2012, the lowest two-year total since 2006, data compiled by Bloomberg show.

The state’s securities have returned 6.9 percent this year, compared with 5.8 percent for the broader muni market and 2.4 percent for Treasuries, Bank of America Merrill Lynch data show.

California localities are still feeling the pinch of the recession that ended three years ago. San Bernardino, a city of 209,000 east of Los Angeles, said last week it will defer paying $3.4 million in pension bonds and $2.2 million toward retiree health care to tide it over before seeking court protection.

At the state level, California has made fiscal progress. June marked the first time in a dozen years the world’s ninth-biggest economy accomplished a second-consecutive timely budget. S&P said the plan’s “realistic” deficit solutions merit a positive debt outlook. S&P rates California A-, seventh-highest.

“People are more comfortable with what’s going on in the Golden state,” said Bud Byrnes, president and chief executive officer of RH Investment Corp., a muni-bond trading company in Encino, California.

Following are pending sales:

CALIFORNIA STATE UNIVERSITY plans to sell about $365 million of revenue bonds as soon as tomorrow, according to data compiled by Bloomberg. A $16.8 million portion will be taxable. Moody’s Investors Service rates the debt Aa2, third-highest. Proceeds will go toward refunding and projects such as construction of campus buildings, according to S&P. (Added July 31)

New York’s TRIBOROUGH BRIDGE & TUNNEL AUTHORITY plans to sell about $1.2 billion of revenue bonds as early as this week, according to an offering statement. Proceeds will be used to refund debt. (Updated July 31)

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