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By Emily Freeman
July 24 (Bloomberg) -- Debt of Connecticut is on pace to beat the municipal market for the first time since 2010 even as the wealthiest U.S. state contends with a struggling economy and the nation’s second-biggest pension liability.
The state of 3.6 million people, including the hedge-fund enclave of Greenwich, plans to sell $200 million of general obligations today, two years after a record tax increase. With its residents shouldering the country’s third-heaviest burden of state and local levies, Connecticut can anticipate demand for the securities, said Bill Ahern at Eaton Vance Management and Howard Cure at Evercore Wealth Management LLC.
Buffeted by job losses in the finance industry, Connecticut was the only state to see its economy shrink in 2012, according to the U.S. Bureau of Economic Analysis. Investors seeking tax-free borrowings are looking past the fiscal challenge, helping shield the state’s bonds from the biggest losses in almost three years in the $3.7 trillion market.
“There’s always an appetite for Connecticut debt because it has the highest per-capita wealth in the country, and as we know, taxes have gone up,” said Ahern, who oversees the $109 million Eaton Vance Connecticut Municipal Income Fund in Boston.
The performance of Connecticut bonds shows how the century-old tax-exemption on municipal debt can lower borrowing costs for states and cities, even as congressional lawmakers work on plans to rewrite the U.S. tax code. The legislators’ approach, which would eliminate some breaks as a means of raising revenue for the U.S. government, is spurring municipalities to lobby on the exemption’s behalf.
The extra yield buyers require on Connecticut securities has diminished this year. Investors demand a yield spread of about 0.28 percentage point above benchmark debt, down from a 2013 peak of about 0.4 percentage point in January, data compiled by Bloomberg show.
Debt from the state has lost 2.6 percent in 2013, less than the decline of 3.4 percent for the whole market, putting it on pace to outperform all local securities for the first time in three years, Barclays Plc data show.
Bonds from nearby New York and New Jersey have lost 3.5 percent and 3.4 percent, respectively. They are the only states where residents bear a higher tax burden than in Connecticut, according to the Washington-based Tax Foundation.
“Connecticut bonds have always marketed well because we have a number of high-income individuals who would like to receive tax-deductible interest off of federal and state levels,” said Ben Barnes, head of Governor Dannel Malloy’s budget office.
Proceeds from the sale will fund building projects, including energy-saving steps, as well as work at state universities and community colleges.
The bonds are rated Aa3 by Moody’s Investors Service, fourth-highest, and AA by Standard & Poor’s, third-highest. The companies cited Connecticut’s income levels as a strength. Per-capita personal income of about $58,000 in 2011 was the nation’s highest, according to S&P.
At the same time, Moody’s said the “slow pace of economic recovery will continue to challenge the state’s financial position.”
As U.S. gross domestic product grew 2.2 percent in 2012, Connecticut’s economy shrank 0.1 percent, according to the Bureau of Economic Analysis. The strain extended to the first quarter, when Connecticut’s overall economic health was the fifth-weakest among the 50 states, data compiled by Bloomberg show.
In June, the state’s unemployment rate was 8.1 percent, compared with 7.5 percent in neighboring New York and 7.6 percent nationwide.
Finance, including banks and insurers, has been among the weakest areas, according to the state Labor Department. The industry has seen 23 straight months of year-over-year job losses, leaving the employment level close to the lowest since 1997.
“The number of jobs in the finance sector has been reduced and those are long-term reductions,” Barnes said. “It has disproportionately impacted Connecticut and our job base.”
Malloy, a Democrat, helped stem the losses. In 2011, Zurich-based UBS AG, Switzerland’s largest bank, promised to keep at least 2,000 jobs in Connecticut under a five-year agreement in which the company would get a $20 million “forgivable” loan.
Moody’s also said the state’s pension-funding ratios will probably remain below average.
Connecticut has the nation’s second-highest pension liability as a percentage of revenue, at about 190 percent, according to Moody’s. Illinois ranks first, with 241 percent.
Last month, Connecticut lawmakers approved a two-year, $37.6 billion spending plan. Republicans criticized the budget for relying too heavily on one-time income, including a tax amnesty program.
“There should be demand from Connecticut residents because it’s a relatively high-tax state,” said Cure, director of muni research at New York-based Evercore, which oversees $4.7 billion. “I don’t think they will have any problem placing that paper.”
Top-rated Maryland joins Connecticut issuing today. Borrowers are offering $6.6 billion in debt, down from $8.6 billion last week, as sales slowed following Detroit’s bankruptcy filing.
Municipal yields are closest to the lowest in a month. At 2.75 percent, yields on benchmark 10-year munis compare with 2.5 percent for similar-maturity Treasuries.
The ratio of the yields, a gauge of relative value, is about 110 percent. The figure has averaged about 93 percent since 2001. The higher it is, the cheaper munis are compared with federal securities.
The municipal market has lost about 0.8 percent this month, compared with a 0.2 percent gain for Treasuries, Bank of America Merrill Lynch data show.