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California's $10 Billion Ran Sale Tied as Largest Ever

AUG 9, 2012 6:52pm ET
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SAN FRANCISCO — California will sell $10 billion of revenue anticipation notes next week in one of the state's largest such cash-flow management deals.

The Ran sale will be almost twice as large as California's 2011 note sale, as the state's normally uneven cash-flow schedule has an additional layer of uncertainty because of a November tax ballot measure.

The Rans will be offered to retail investors in an order period Tuesday and Wednesday, followed by institutional pricing Thursday.

With yields at record lows, retail investors are expected to be hungry for the paper.

"In the past, retail has gone into Rans hand over fist, then of course, the institutions, and then money market funds," said Marilyn Cohen, founder of Envision Capital Management in Los Angeles. "As a parking spot, the Rans will be gobbled up by retail."

Cohen said the time is ripe partly because the notes should yield more than the infinitesimal one or two basis points retail investors are getting in their tax-free money market accounts.

The Rans will yield more than money markets, but dramatically less than some recent California note deals.

In 2008, amid a cash crunch, state budget crisis and global uncertainty after the collapse of Lehman Brothers, California had to offer yields between 3.75% and 4.25% to sell $5 billion of Rans.

A year later, the state sold $9 billion of Rans with a top yield of 1.5%.

This year's sale will more likely be akin to that of last year, when California sold $5.4 billion of Rans in September that yielded 0.38% for a May 2012 maturity and 0.40% for those due in June.

Around 65% of that deal went to retail.

This year JPMorgan and Wells Fargo are joint senior managers, De La Rosa & Co is co-senior manager, and 36 other firms are part of the syndicate.

A money manager who declined to be named said the broker-dealers are already hot on the deal, saying, "I am even getting calls from my friends."

This year's Ran sale is seen as likely to avoid the complications that hit last year's.

Treasurer Bill Lockyer took out a bridge loan in July 2011 from a group of eight banks in an effort to avoid potential market chaos caused by Congress' wrangling over the debt ceiling.

After the debt ceiling drama concluded, the treasurer's office sold the Rans in the public debt markets in the fall and repaid the bridge loan.

A similar problem occurred in 2010, though state-level dysfunction was to blame.

The Treasurer's Office negotiated a bridge loan of $6.7 billion to give the state time to prepare a Ran sale after the state budget was adopted 100 days late. The treasurer then sold $10 billion of notes in the public markets that November, paying off the bridge Rans.

That $10 billion note sale will be tied with this year's deal as California's largest single Ran sale, though California actually sold more Rans in 2002. That year, the Ran deals were split into separate $9 billion fixed-rate and $3.5 billion variable-rate transactions.

Cash-flow problems in recent years have led California to create more tools to shore up its cash position until revenue comes in later in the year during income tax season.

According to Fitch Ratings, California's borrowable balances climbed to $20.8 billion at year-end, from $17.4 billion assumed at the start of the fiscal year, despite the general fund ending fiscal 2012 on June 30 without a cash balance and with loans from borrowable funds of $9.6 billion.

One of those tools is to defer payments owed to different agencies until later in the fiscal year. The Department of Finance estimates deferrals will improve the state's cash position by up to $2.7 billion in certain months.

Cash-flow problems associated with late budgets appear to have been abated by Proposition 25, which passed in 2010. The measure requires lawmakers to pass a budget on time or else forfeit their pay. It also lowered the threshold for passing a budget to a majority of votes from a two-thirds supermajority.

Those tools also helped the state mitigate an unexpected cash-flow problem earlier this year when Lockyer had to sell $1 billion of privately placed debt in February as part of a plan to shore up cash after Controller John Chiang warned that California would run out of cash unless it adopted $3.3 billion of short-term measures.

For these reasons and others, rating agencies have given this year's deal top marks.

Moody's Investors Service gave the notes a short-term MIG 1. Standard & Poor's assigned the Rans an SP-1 plus. Fitch rated them F1.

Analysts said the state should have no problem paying back the Rans despite the size of the deal, this year's reliance on more revenue later in the year and the uncertainty posed by the November election.

The fiscal 2013 budget relies on voters' approval of a tax initiative in November to raise an estimated $5.5 billion of revenue. The measure would temporarily increase California's sales tax by one-quarter of a cent and raise taxes on income starting at $250,000. It's a key component of Gov. Jerry Brown's $91.3 billion general fund spending plan.

If voters reject the measure, the spending axe will fall mainly on education through about $6 billion of "trigger cuts."

The unusual nature of this year's budget is driving the state to borrow much more short-term debt than it did last year because the budget that was passed in June relies on measures to generate revenue later down the road, such as the temporary tax increase proposed by Brown or the cuts that will be triggered if the initiative fails.

Because of the potential effect the cuts would have on schools, the state reduced the amount of payment deferrals it forced on schools in the early months of the current fiscal year compared to recent years.

"The net effect of these factors caused the state to need a larger cash flow borrowing this year," said Standard & Poor's analyst Gabriel Petek.

Petek said that despite the larger amount of borrowing and potential budget problems, the state still should have no problem retiring the Rans.

"The state still has considerable fiscal challenges for the longer term, which we are very aware of," Petek said. "You have to look at this and objectively acknowledge their capacity and demonstrated willingness to repay these notes at maturity is particularly strong."

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A recent phenomenon is the emergence of bonds with shorter call protection as funding alternatives for municipalities. However, the shorter call protection also dampens the potential upside for investors, which in turn reduces the price they are willing to pay.

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