Bloomberg News

California May Pay More to Borrow Amid Revenue Gap: Muni Credit

October 14, 2011

Oct. 14 (Bloomberg) -- California, facing mandatory spending cuts with revenue below forecast, may have to pay almost 15 percent more to borrow $2 billion this month than it did in September as municipal yields climb to a 10-week high.

Top-rated 10-year tax-exempt yields exceeded 2.57 percent yesterday, the highest since Aug. 3. They’ve jumped from 2 percent on Sept. 26, the lowest since the Bloomberg Valuation index began in January 2009, as weekly state and local debt sales reached $8.8 billion, the most of 2011.

California, the most-indebted U.S. state, issued $2.4 billion of general-obligation bonds last month at yields about a third less than two years earlier as investors rewarded the budget passed by Governor Jerry Brown and Democrats in June. It may get a cooler reception this time after fiscal first-quarter revenue came in $705 million below projections and as 10-year yields posted their biggest five-day advance since November.

“There’s a volatile market, with negative news in terms of their financial position,” said Gary Pollack, head of fixed- income trading in New York at Deutsche Bank Private Wealth Management, which has $12 billion of assets. “California is going to need to come in on the wider end of the spread range that it’s been trading in.”

California state and local bonds have outperformed all municipal debt and U.S. Treasuries this year, providing investors with a 10.1 percent return, according to Bank of America Merrill Lynch indexes that combine price gains and interest payments. Treasuries returned 7.4 percent and municipals returned 7.6 percent, the indexes show.

Lowest-Rated State

The state’s $70.1 billion of general-obligation bonds are rated A- by Standard & Poor’s, its fourth-highest investment grade and the lowest among U.S. states. Moody’s Investors Service rates the state A1, its sixth-highest rank.

Next week’s general-obligation issue, planned for Oct. 17, is California’s second since the end of a 2011 moratorium on sales meant to curb borrowing costs as lawmakers worked to complete their budget.

When the state sold $2.4 billion of similar debt last month, 10-year bonds were priced to yield 3.17 percent, or 109 basis points more than the top-rated index. A 5 percent security sold then traded yesterday at a 3.51 percent average yield, according to data compiled by Bloomberg, about 94 basis points more than the index. A basis point is 0.01 percentage point.

Even Wider

Pollack said he “wouldn’t be surprised” if the state had to price yields “closer to the 125 range” at next week’s sale. A difference of that much would boost borrowing costs by 14.7 percent from the premium California paid in September.

The market “is a little weaker now then it was last month,” Tony Shields, a senior trader at Charles Schwab & Co. in Jersey City, New Jersey, said in a telephone interview. “Last month there wasn’t much supply, and now there seems to be some supply so they’ll do fine, but they’re going to have to obviously adjust for the change in rates.”

California’s tax revenue in the first three months of the fiscal year that began in July fell $705 million below projections, the state said on Oct. 10.

Brown and his party counted on as much as $4 billion of revenue gains in their $86 billion annual general-fund budget, which used $12 billion of spending cuts and other measures to close a $26 billion projected deficit.

The budget includes a provision that triggers automatic spending cuts if the extra $4 billion appears unlikely by year’s end.

Credit Positive

“That’s an awesome credit positive,” said Alan Schankel, director of fixed-income research for Janney Montgomery Scott LLC in Philadelphia, which manages $11.8 billion in fixed income. “If the revenues aren’t coming in, then there is a mechanism to make sure there isn’t a shortfall.”

The first tier of reductions, if the gap is $1 billion, would trim University of California and California State University budgets by $100 million each, increase community- college fees by $10 per unit and cut in-home services for the elderly and disabled.

All but $200 million of next week’s sale is of tax-exempt securities, according to the preliminary offering statement on the treasury’s website. Proceeds from the sale can be used for public projects such as prisons, parks, schools and levees.

Treasurer Bill Lockyer also plans to use $133 million to refinance taxable Build America Bonds sold in a 2009 private offering to the Los Angeles County Metropolitan Transportation Authority.

Following is a description of coming municipal sales:

VIRGINIA COLLEGE BUILDING AUTHORITY will sell $156 million of education-facility revenue bonds as soon as Oct. 18 through competitive bids. The bonds will finance capital projects on six campuses. Fitch Ratings grades the bonds AA+, its second-highest rank. (Added Oct. 14)

DISTRICT OF COLUMBIA will sell $104 million of revenue bonds as early as Oct. 17 to finance a new headquarters for the Association of American Medical Colleges. Bank of America Merrill Lynch will lead the sale. The bonds are rated A+ by S&P, the fifth-highest grade. (Added Oct. 14)

LOS ANGELES COUNTY METROPOLITAN TRANSPORTATION AUTHORITY, the largest public-transit operator west of Chicago, plans to issue about $235 million of revenue bonds as soon as Oct. 27, according to an offering statement. Proceeds will refund debt issued in 2001, retire some commercial paper and help build reserves. The bonds are rated Aa2, Moody’s third-highest grade. Stone & Youngberg LLC will lead banks. (Added Oct. 13)

PENNSYLVANIA, whose capital city of Harrisburg filed for bankruptcy this week, plans to sell $826 million of tax-exempt general-obligation debt through competitive bids on Oct. 18, according to a preliminary official statement. Proceeds will finance public works and refund debt. The state is rated AA, S&P’s third-highest grade. (Added Oct. 13)

--With assistance from Michelle Kaske and Andrea Riquier in New York. Editors: Jerry Hart, Pete Young

To contact the reporter on this story: Michael B. Marois in Sacramento at mmarois@bloomberg.net

To contact the editor responsible for this story: Mark Tannenbaum at mtannen@bloomberg.net


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