July 2 (Bloomberg) -- Investors in the $3.7 trillion municipal market are betting California is headed for the best credit rating in a decade as recovering housing prices help its economy grow the most out of the five largest U.S. states.
The improvement in the world’s ninth-biggest economy has buoyed California bonds. The yield penalty that investors demand on the state’s obligations shrank to 0.44 percentage point last week, the smallest since 2008, data compiled by Bloomberg show. The most-populous U.S. state is also the most-indebted, with about $103 billion of gross tax-supported debt in 2012, the highest in a Moody’s Investors Service ranking.
Governor Jerry Brown forecasts an $817 million surplus this year. It would be the first in nearly a decade after California strained under more than $100 billion in cumulative deficits since 2007. Moody’s grades the state A1, four steps below the top, and hasn’t given it a higher rank since 2001.
“The perception of California from an investor’s perspective is that it’s on an upswing,” said Robert Miller, who helps oversee $34 billion of munis at Wells Capital Management in Menomonee Falls, Wisconsin. “I don’t think there is anybody out there who doesn’t think that they are going to receive an upgrade at some point.”
California’s overall economic health, as measured by tax collections, home prices, mortgage delinquency, jobs, personal income and performance of local stocks, grew 3.8 percent in the first quarter, according to data compiled by Bloomberg. In the Bloomberg Economic Evaluation of States index for the period, California beat Texas, New York, Florida and Illinois.
Home prices rose 6.5 percent in the quarter compared with a year earlier, also the best among the largest states, according to California’s FHFA House Price Index. In January, the state got its first Standard & Poor’s rating boost since 2006.
The jobless rate in California, with 38 million residents, fell to 8.6 percent in May, the lowest since 2008 and down from 12.4 percent in 2010. Only five states have a higher level.
Brown, a 75-year-old Democrat, persuaded voters in November to pass the highest statewide sales tax in the U.S., at 7.5 percent, and to boost levies on annual income starting at $250,000. He said the higher levies were needed to avert cuts to schools.
He has also said the economic recovery is too fragile to justify more spending and remains at risk from federal policies.
The $96.3 billion budget for the fiscal year that began yesterday assumes revenue growth will slow and the state’s economy will be curbed by higher federal payroll taxes and automatic U.S. budget cuts. The spending plan is up less than 1 percent from last year’s.
“It’s very imprudent for people to go around saying we have money to spend,” Brown told reporters last week in Sacramento, the capital. “We don’t have the money until it’s in the bank.”
While California’s fiscal position is the strongest in several years, the latest spending plan is weaker than the one Brown proposed in May, S&P said in a report yesterday.
The deal Brown struck with lawmakers to finance some health and welfare expansions delays the repayment of some liabilities left over from previous budget deficits, the company said.
Some of the improvement in California yield spreads in June may also have resulted from investors being drawn to the bonds as municipal interest rates soared, according to Dan Solender, director of munis at Lord Abbett & Co. in Jersey City, New Jersey.
Benchmark muni yields reached the highest since 2011 last week, part of a broader fixed-income selloff as investors speculated that an improving U.S. economy will lead the Federal Reserve to scale back its bond buying.
California is still on a better trajectory than in the first quarter of 2012, when it ranked 17th in terms of economic health on the BEES index.
The median price for an existing single-family home in California jumped to $417,350 in May, up 32 percent from a year earlier as a shortage of houses on the market sent home prices in the state up the most in three decades, according to the California Association of Realtors.
A separate benchmark measuring the state’s economy strengthened in April to the highest since February 2008, according to the California Business Index compiled by Comerica Bank.
California “is representative of an economy that is repairing itself and is coming back to a true recovery mode,” said Robert Dye, chief economist for Dallas-based Comerica.
The accumulation of homeowner equity and job growth is fueling the recovery, Dye said.
“Homeowners are building equity very very rapidly right now and that is a huge positive wealth effect,” Dye said by telephone. “When you combine that with moderate gains in employment, you are starting to see a consumer that is more resilient and you are seeing businesses that are responding.”
When California sold general-obligation bonds in April, the state priced 10-year securities to yield 2.37 percent, about 0.58 percentage point above benchmark munis.
“It’s such a liquid credit and the positive outlook helps, the tax rates going up in California helps,” said Solender, whose firm oversees $19.5 billion of local debt. “There’s just a lot of positive things going for it.”
In the municipal market this week, borrowers plan to offer a combined $2.8 billion of bonds, the least since January.
At 2.75 percent, benchmark 10-year muni rates compare with about 2.5 percent on similar-maturity federal debt.
The ratio of the yields, a gauge of relative value, is about 110 percent, close to the highest since August. The average since 2001 is about 92 percent. A higher percentage means munis are cheaper relative to federal securities.
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