Bloomberg News

California Beats Bond Forecast on Default-Risk Drop: Muni Credit

October 19, 2011

Oct. 19 (Bloomberg) -- California, with the best-performing debt among U.S. states, is defying forecasts its borrowing costs would rise as much as 15 percent on a $1.8 billion sale, signaling confidence the lowest-rated state won’t default.

The biggest municipal issuer today priced the offer with a preliminary yield of 3.60 percent on 10-year bonds, or 116 basis points above benchmark interest rates on top-rated 10-year state and local debt, a Bloomberg Valuation Index shows. That’s up from a gap of 109 basis points in a sale last month. The increase falls short of what Gary Pollack at Deutsche Bank Private Wealth Management predicted. He said last week the gap might swell to as much as 125 basis points, or 1.25 percentage points, as municipalities sold the most debt this year.

California’s securities are in short supply after Governor Jerry Brown, to curb debt-service costs, imposed a nine-month sales moratorium that cut issuance by more than half from last year. Buyers may also be encouraged by spending cuts that would be triggered if revenue trails projections by at least $1 billion this fiscal year.

Investors “have been more comfortable with the state lately and they’ve done a few things in terms of their budgeting process,” said Michael Pietronico, who manages $590 million as chief executive officer at Miller Tabak Asset Management in New York.

“It looks like the sentiment toward the credit has improved,” he said in an interview.

Market Rebound

The most-populous U.S. state is also benefiting from a rebound in the $2.9 trillion municipal market. Yields on top- rated 10-year bonds fell for a fourth day. They dropped to about 2.44 percent today after reaching a two-month high of 2.58 percent Oct. 14 following the biggest week of borrowing this year. Local governments sold about $8.9 billion of debt in the Oct. 7 week, the most since December. Municipalities plan $7.9 billion of sales this week.

California raised the rates on the 10-year bonds after marketing them earlier this week to individual investors at 3.51 percent. The latest rate is about 14 percent higher than it paid last month on bonds of similar maturity. That is still below the 17 percent increase on benchmark 10-year muni yields in the same period, according to a BVAL Index. The sale, which includes maturities from 2014 through 2041, concludes today.

Debt from California state and local issuers has earned 9.1 percent this year, the most among 26 states tracked by Standard & Poor’s Municipal Bond indexes. Illinois, with the same A1 rating from Moody’s Investors Service, is second with an 8.7 percent return. The credit grade is the company’s fifth-highest.

2011 Sales

California is set to offer $12.7 billion of debt this year, compared with $27 billion in 2010, according to data compiled by Bloomberg. State Treasurer Bill Lockyer sold $2.5 billion of general-obligation bonds last month.

Pollack at Deutsche said before this week’s sale that California might pay a larger spread as municipal yields increased along with issuance.

“Supply is a little bit more manageable,” said Pollack, head of fixed-income trading at the New York unit of Germany’s biggest lender.

The state said last week that tax revenue in the first quarter of the fiscal year was $654 million below projections. Brown and his fellow Democrats counted on as much as $4 billion of revenue gains to help close a $26 billion projected deficit in the general-fund budget.

Automatic Cuts

The spending plan includes automatic spending cuts if the extra revenue appears unlikely by year-end. Those so-called triggers led Standard & Poor’s in July to rescind the state’s negative long-term outlook.

“California’s still going to pay principal and interest in a timely fashion, despite the headline risks,” said Pollack, who helps oversee $12 billion of assets. “As long as I can stomach that risk, I’m earning a lot of additional yield for it, and I think a lot of investors are willing to get paid for that type of risk.”

The credit-default swaps market is also signaling investors are less concerned about the debt. The cost of protecting California bonds against default for 10 years is 252 basis points, down from about 300 basis points in January, according to market prices compiled by London-based CMA. The cost is 13 basis points more than a benchmark index, down from a difference of about 60 basis points in January.

The state can spend the proceeds on public projects such as prisons and parks. Lockyer will use $133 million to refinance taxable Build America Bonds sold in a 2009 private offering to the Los Angeles County Metropolitan Transportation Authority. He also is selling $200 million of taxable bonds.

--With assistance from James Nash in Sacramento. Editors: Mark Tannenbaum, Jerry Hart

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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