California's Bond Bull Run May Have Run Its Course

  • Loop Capital’s survey shows buyers don’t anticipate upgrades
  • State’s yields have risen relative to benchmark debt

Some bond buyers are losing faith in California’s bull run.

With the state’s credit ratings at their highest since the turn of the century, one underwriter’s private survey found that investors see little room for more upgrades.

A majority of firms canvassed by Loop Capital Markets said California’s rating has hit or is nearing a "high-water mark,” according to a December presentation to the state treasurer’s office that was obtained through a public records request. The caution was seen in the pricing of a $2.7 billion general-obligation debt sale last week, when buyers demanded higher yields, relative to top-rated securities, than they did in October’s sale, according to data compiled by Bloomberg.

One firm in the survey said it didn’t like the "fundamental way the state deals with budget issues." Another said California’s rating would remain constrained "unless the state finds a way to spread the tax burden more broadly and becomes less dependent on taxing the ultra-wealthy."

The anonymous sampling -- of six bond funds, two bank portfolio managers, two insurance companies and two managers of individual accounts -- underscores the risks in investing in the most populous U.S. state. While California has paid down debt, turned budget deficits into surpluses and socked more away into reserves, it still is vulnerable to swings in the stock market, which is holding near a record high. The top 1 percent of earners, who tend to own shares, accounted for nearly half of its personal income-tax collections in 2014. One firm in the Loop survey cited that "high concentration" as the "most critical factor" in deciding whether to buy more California debt.

The extra interest, or spread, investors demand to hold California 10-year bonds instead of top-rated debt widened to about 0.3 percentage point from as little as 0.09 percentage point in late August, which was the lowest since at least 2013, data compiled by Bloomberg show.

That doesn’t mean investors have soured on the state: most of the 12 firms polled by Loop expressed confidence that the state will maintain its grades, which are the fourth-highest from Moody’s Investors Service, S&P Global Ratings, and Fitch Ratings. All three have a stable outlook on California, indicating they don’t anticipate changing it soon. And most surveyed by Loop said they have room to buy more debt, which is important, given that the state is already planning to sell at least $1.37 billion of bonds this month and in April.

Risks they cited included the national economy, widening spreads, growing retirement costs and the end of Governor Jerry Brown’s tenure in 2019, since he can’t run again because of term limits. One firm is "concerned that leading candidates will not have the willingness of Brown to battle the legislature."

Jorian Seay, a Loop spokesperson, declined to comment.

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