Buy Side

California: Raws, Rans, or Other?

The most important bonds in California right now are the ones that haven’t been issued yet — and may never be.

Howard Cure, who joined Evercore Wealth Management as director of municipal research this year, is keeping an eye on how the Golden State closes its $21 billion to $24 billion budget gap.

If the state did sell revenue anticipation warrants, Cure said, it would likely have to offer a fat yield to entice investors.

That could force a cascade away from the state’s long-term bonds, Cure said.

It would be tough to justify owning a 30-year general obligation bond in a financially strapped state when a one- or two-year note is yielding almost as much, Cure said.

As opposed to revenue anticipation notes, which are short-term borrowings repaid the same year, Raws defer repayment to ensuing years.

Raws typically offer higher interest rates, one of the reasons the California Legislative Analyst’s Office described them as “a terrible precedent and a poor fiscal policy.”

Gov. Arnold Schwarzenegger in a proposed budget this month considered selling $6 billion of Raws, a plan he scrapped last week after the U.S. Treasury refused to back the debt.

The Democratic-controlled Legislature, which would like to make less drastic spending cuts, has not yet passed a budget plan and could include Raws in its budget-balancing measures.

Raws are not part of the governor’s current budget proposal, but Treasurer Bill Lockyer told the Legislature this week a Raw sale remains a possibility.

Cure points to the state’s $5 billion Ran sale in October as a benchmark for guessing at where California Raws might price.

Some portion of that note sale priced at a yield of 4.25%.

(It should be noted that The Bond Buyer one-year note index is at an all-time low of 0.58% this week, 200 basis points lower than October.)

Now, the state’s budget deficit is even more gaping. The state is begging the federal government for help, its unemployment rate is 11%, and property values remain in free fall.

Earlier this month, voters struck down five propositions that would have made it easier for California to raise cash.

“I have to expect now, with the budget deficit being bigger, the propositions having failed, and with such [taxpayer] discontent, that the yield might be even higher,” Cure said.

It is questionable whether Raws would be eligible for purchase by some money-market funds because of California’s ratings woes, Cure said. California is the lowest-rated state in the Union.

To attract new investors, Cure said he would not be surprised to see California Raws price at a yield of 5%.

“That can make everything else in California look rich,” he said.

According to Municipal Market Data, the 30-year California GO scale yielded 5.79% yesterday.

Investors would have to reprice bonds all along the yield curve if short-term notes offer fetching yields, he said.

“Why would you go for 30-year paper at hardly any increase in yield?” he said. “If there’s a hesitancy to go out long and there’s not much of a benefit, then I think the [short-term] note looks very attractive. ... I think a lot of it may be driven by the competition that’s going to be occurring because of the California notes.”

Before joining Evercore, Cure was director for 11 years in the public finance department at Financial Guaranty Insurance Co. He has also worked at Prager, Sealy & Co., Moody’s Investors Service, and the New York State Senate Finance Committee.

The potential impact on the curve from short-term notes is only one reason Cure has a cautious outlook on the state’s GO debt, as well as local bonds issued within the state.

California’s reliance on personal income taxes, especially on the wealthiest sliver of the population, leaves the state vulnerable to severe cyclical swings, he said.

The three major rating agencies have each downgraded or upgraded California’s credit at least 14 times since 1980.

Add to that a legislative process that makes it easy for politicians to hold the budget and tax policy hostage and people voting on convoluted propositions they hardly understand and, as Cure put it, “the problems are practically endless.”

Cure advises caution on city and county debt in the state too. The state government is proposing to “borrow” (the quotation marks are Cure’s) up to 8% of cities’ property taxes, to be repaid within three years.

Proposition 1A in 2004 permitted the state to borrow local property taxes only in a fiscal emergency.

Cure is paying attention to whether local governments are prepared for this ­outcome.


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