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California Market On Hold

MAY 12, 2011 6:40pm ET
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SAN FRANCISCO — As Gov. Jerry Brown readies the release of his second shot at a balanced budget next week, the California bond market has become hamstrung by the delay.

Uncertainty about passage of a balanced budget has caused California — the largest seller of municipal debt — to hold back on issuing any new paper, and has also kept state municipalities out of the market because of unknowns surrounding the budget’s impact.

As a result, the lack of new bonds in an already shallow debt market has caused investors to flock to quality short-term bonds and others to bargain hunt in the opposite end of the secondary market, said Bud Byrnes, chief executive at Encino, Calif.-based RH Investment Corp., a broker-dealer specializing in California municipal bonds.

“This is as unique of a situation in the California bond market as I have seen in my 30 years in the midst of it,” he said. “The state should be able to conduct its normal business despite the budget impasse, but it can’t.”

Byrnes said investors have been paying dear prices for California paper with maturities inside five years, while others have been buying at high yields in older maturities to hedge against any potential interest rate hikes by the Federal Reserve.

Until the budget passes, he said he ­expects the market to stay the same, or get worse in the case of an unforeseen event.

California general obligation bonds maturing in 2040 initially sold in March last year at a price of 97.84% of par and a yield of 5.5% traded on Wednesday for 101.66% and yield of 5.26% in a block of more than one million, according to the Municipal Securities Rulemaking Board.

The same bonds maturing in 2016 and initially priced at 101.83% to yield 3.5% traded on Wednesday for 105.64% at a 2.25% yield in a block of 200,000.

In the overall market Wednesday, the 10-year muni yield fell four basis points to 2.70%, according to Thomson Reuters, its lowest since Nov. 12. The two-year yield fell four basis points to 0.50% and the 30-year yield fell two basis points to 4.43%.

The market has also suffered from a shortage of issuance this year after a deluge of Build America Bonds sold before the program expired at the end of 2010.

Municipal bonds sold in the first ­quarter of this year total just $46.94 billion, the weakest volume since the first quarter of 2000 and 55% less than the same period last year, according to Thomson Reuters.

California has no plans to go to market until the fall, and even that is far from ­certain. “We still hope to be in the market this fall to sell $5.5 billion to $6 billion of GO bonds.  But the treasurer has no interest in selling bonds without a balanced budget in place,” said Tom ­Dresslar, a spokesman for state Treasurer Bill ­Lockyer.

Dresslar said GO-bond financed public works programs have enough funds to make it though the end of the calendar year, but added that if the state doesn’t go to market until next year current projects could face a shutdown.

California’s annual revenue anticipation note sale this summer, potentially in the $10 billion range, is also contingent on the state budget.

“We cannot sell Rans without a budget in place — not just any budget, but one that provides investors confidence the state will have adequate cash coverage to pay off the Rans when they come due,” Dresslar said.

The state’s fiscal year ends June 30. Lawmakers rarely adopt a budget on time; in 2010, it took until Oct. 8.

 “I think everyone is watching [budget negotiations] very carefully but we certainly don’t expect anything to happen overnight,” said Alexander Anderson, a portfolio manager at Envision Capital in Los Angeles. “Issuance is way down this year. It is not just the state, it is that other municipalities are not issuing bonds at all.”

Some cities and agencies have held off from selling any new debt until they know the amount of revenue they will get from the state. In California, the majority of tax revenue tagged for cities is collected by the state and then distributed.

California governors release a “May Revise” budget proposal every year to reflect circumstances that change after the initial January budget proposal.

Brown will release the revised budget Monday outlining plans to close a $15 billion hole remaining after he was unable to persuade lawmakers to call a special election asking voters to extend temporary tax increases.

Brown’s original budget mixed spending cuts with revenues from the tax extensions and from his plan to shutter redevelopment agency tax districts, to plug a $26 billion hole in the $86 billion general fund budget. All he got was the cuts.

The governor, a Democrat, was unable to garner votes from the Republican minorities in the Legislature to obtain the two-thirds majority needed to call the special election or shutter the redevelopment agencies.

Standard & Poor’s last month affirmed its A-minus long-term underlying rating on California’s general obligation debt and maintained its negative outlook due mainly to the fractured budget negotiations.

The rating agency’s main concern is that the state will have too little cash to fund operations if the budget negotiations are drawn out too long, Standard & Poor’s analyst Gabriel Petek said in a report.

The result, Petek noted, is the state controller may have to take aggressive cash-management actions.

In 2009, Controller John Chiang issued $2 billion of IOUs to lower-priority creditors to preserve cash for creditors with higher legal standing, such as bondholders. The state ultimately redeemed the IOUs.

So far this year, Brown has signed into law $11.2 billion worth of solutions to fill the gap, most of them spending cuts, out of $14 billion passed by the Legislature, leaving roughly a $15 billion general fund deficit, according to the state Department of Finance. The tax extensions alone would provide $11 billion in fiscal 2012, according to a legislative staff report.

Brown ended negotiations after failing to find common ground with ­potential GOP swing voters for a package that would include pension reform, reduced business regulations, and a spending cap in return for allowing the tax vote to ­proceed.

Local governments have also shown strong resistance to Brown’s plan to shut down the redevelopment agencies, which are a significant pot of locally controlled money. Finance Department spokesman H.D. Palmer has said officials are working with the governor this week to finalize the revised budget and would not comment further on potential changes, such as scheduled bond sales.

California has more than $71 billion of voter-approved GO bonds outstanding, and has $37 billion in authorized bonds that remain unissued, according to the state treasurer’s office.

So far this fiscal year, tax revenues are $2.5 billion ahead of projections, according to Controller Chiang, but gains have been mitigated by Brown’s announcement in March that he will abort a sale of state buildings that had been expected to generate $1.2 billion.

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