California Rising With Banks Vying to Sell New Debt: Muni CreditMichael B. Marois
California, which relies on private deals with banks for almost 80 percent of its bond offerings, plans its biggest competitive debt sale in six years as the state’s relative borrowing costs sink to the lowest level since 2008.
Governor Jerry Brown, 75, forecasts an $817 million surplus this year, the first in almost a decade, after the world’s ninth-biggest economy ran up more than $100 billion of deficits since 2007. With Fitch Ratings and Standard & Poor’s raising the state’s credit grade, buyers of California debt maturing in 10 years are demanding as little as 0.36 percentage point of extra yield over top-rated munis, data compiled by Bloomberg show. That’s about the least in five years.
Tomorrow’s $764 million sale of general obligations includes bonds maturing from 2014 to 2033, according to Bloomberg data. The issue “should find decent demand,” said Daniel Solender, director of munis at Lord Abbett & Co. in Jersey City, New Jersey, even as investors have withdrawn $21 billion from local-debt mutual funds in the past 12 weeks.
The fund outflows have been triggered by yields on benchmark municipal securities rising to the highest in more than two years amid concern over Detroit’s record $18 billion bankruptcy and uncertainty whether the Federal Reserve will curb debt purchases. Yet demand from consumers for individual bonds will help buoy the California borrowing, Solender said.
“Even though fund flows continue to be negative, retail demand seems to be strong as they are buying a good number of bonds with yields rising so much in recent months,” said Solender, who helps manage $19.5 billion of local debt.
Treasurer Bill Lockyer plans to use $559 million from the sale to refinance existing securities that pay a higher interest rate, saving on debt service for the most-populous state. In April, the state sold $2.7 billion in general obligations, pricing some bonds to yield 2.37 percent, about 0.58 percentage point more than the rate on benchmark 10-year munis at the time, Bloomberg data show.
California debt has benefited from demand for tax-exempt income after voters in November boosted levies on residents earning $250,000 or more. They also raised the sales tax, already the highest in the U.S. The increases may generate as much as $6 billion a year, according to the nonpartisan Legislative Analyst’s Office.
Fitch raised California’s grade to A, sixth highest, this month after lawmakers passed a $96.3 billion budget in June that incorporated the Democratic governor’s more conservative revenue forecasts and set aside a $1.1 billion reserve. S&P raised its rating to the same level in January, the first boost since 2006. Moody’s Investors Service grades the state A1, four steps below the top. It hasn’t been higher since 2001.
A strengthening housing market is buoying the state’s economy. California’s unemployment rate dropped to 8.5 percent in June, the lowest since October 2008, according to the state Economic Development Department. It still eclipsed the national average of 7.6 percent that month.
California’s sale is the fourth-largest competitive offering this year, data compiled by Bloomberg show, after Washington sold $1.4 billion in January and another $867 million last month, and Pennsylvania marketed $950 million in April.
The Golden State relied on privately negotiated deals for almost 80 percent of its general-obligation bond sales in the last decade, according to data compiled by Bloomberg.
Lockyer has said that the state’s larger issues, as much as $6.5 billion at a time, require it to select underwriters beforehand. Depending on market conditions, the threshold for a negotiated bond sale is anywhere from $1 billion to $1.5 billion, Lockyer’s spokesman, Tom Dresslar, said by e-mail.
The $3.7 trillion market for local-government bonds used to be more competitive. In 1970, 73 percent of municipal offerings were sold at auction, the U.S. General Accounting Office said in a 1983 report. In such deals, the bank that offers the lowest interest cost via the highest bid, or price, buys the securities and tries to sell them for more.
This year, 25 percent of $204 billion in new fixed-rate issues were sold that way, data compiled by Bloomberg show. The rest were negotiated offerings, in which underwriters are chosen based on assurances they’ll deliver the cheapest rates.
Of the $80 billion of long-term general-obligation bonds California issued in the last decade, $14 billion, or 18 percent, were sold at auction through competitive bidding, according to data compiled by Bloomberg. This year, issuers in California have sold $32.4 billion of municipal debt, only 12 percent through competitive deals.
“Often if issuers do not have too many competitive deals, they get decent bids from dealers who are trying to position themselves to lead negotiated deals,” Solender said. “That should help demand” for this week’s California sale, he said.
The average cost of issuance for negotiated U.S. muni offerings in 2012 was $5.76 per $1,000 of debt, compared with $6.37 for competitive sales, data compiled by Bloomberg show. In each of the previous three years, negotiated sales cost issuers more in fees than auctioning debt competitively.
“I think competitive could actually help the state get a good price because dealers know they should have good retail demand to work through the bonds over time, and they want to get the state’s attention for participation in future negotiated deals,” Solender said.
California’s bond deal is leading $5 billion of long-term debt sales this week, the most issuance for such a period since Aug. 9, data compiled by Bloomberg show.
At 3.1 percent, yields on benchmark 10-year muni bonds are at their highest since April 2011, according to data compiled by Bloomberg. That compares with 2.8 percent for Treasuries with similar maturity.
The ratio of the two yields is about 110 percent, above the five-year average of about 101 percent. The higher the percentage, the greater the relative value of municipal securities compared with Treasuries.
Following is a pending sale:
Texas plans to offer $7.2 billion in tax- and revenue-anticipation notes as early as tomorrow to help manage its cash flow in the fiscal year that begins Sept. 1. The notes mature in August 2014 and are rated SP-1+ by S&P, its highest short-term credit grade. S&P cited the state’s buoyant economy. Similar debt offered by the state about a year ago traded with a yield of 0.15 percentage point Aug. 23, compared with 0.33 percent for an index of top-rated one-year notes.