SAN FRANCISCO — Though plentiful doubts remain about California’s ability to balance its budget, those concerns were no deterrent to bond investors recently.
Retail investors gobbled up a huge share of $2 billion of general obligation refunding bonds this week, at lower yields than the state paid in in the fall.
The deal opened to retail orders shortly after California publicly grappled with a cash crunch, and one day after the state’s nonpartisan budget analyst released a revenue forecast $6.5 billion lower than forecast in the Gov. Jerry Brown’s proposed budget.
“I see it more of a supply and demand equation,” said Alexander Anderson, a portfolio manager with Envision Capital Management in Los Angeles. “California has been up and down for years and years, so having these credit issues in nothing new to California bond buyers.”
The higher demand is partially due to California starving the bond market of state paper for more than a year. There are few regular credit issuers like the Golden State that allow institutional investors to grab large batches of tax-exempt paper along with a bit better yield during the year.
This week’s GO sale, of $1.98 billion in refunding bonds, was California’s first such sale of 2012, and first spring sale in two years.
The state issued 47% of the sale on Tuesday and Wednesday to retail investors at initial yields of 1.28% for five-year bonds, 2.69% for 10-year paper and 3.69% for 20-year bonds. On the second day of retail orders, the state reported that it tightened yields by about a basis point on maturities 10 years and longer.
Barclays Capital, JPMorgan and Wells Fargo Securities are joint senior managers for a selling group of 34 broker-dealers.
Figures from the institutional sale on Thursday were unavailable by press time. Institutional sales are typically at lower rates.
“We were hoping for strong demand, and we weren’t disappointed,” state Treasurer Bill Lockyer said in a statement Wednesday. “This is an excellent retail result.”
In October, the state’s last tax-exempt GO sale, which was also $2 billion, the treasurer’s office sold five-year bonds at a 2.28% yield, 10-year maturities at 3.70% and 20-year bonds at 5.03%. It didn’t release yield figures for 20-year bonds.
The state’s bond spreads are also tightening, no matter what the headlines say about its budget.
California’s 20-year general obligation bonds yield spreads versus an index of triple-A-rated municipal bonds hit 93 basis points on Wednesday, while the state’s five-year GO bond spread hit 57 basis points. Those compare to a 161 basis point spread on the 20-year bond and a 123-point spread on the five-year bond two years earlier, according to Thomson Reuters.
Two years ago, lawmakers were locked in a special session to try tackle a budget deficit after Gov. Arnold Schwarzenegger proclaimed a budget emergency.
Demand appears to be trumping concerns about the California’s financial condition, helping the state achieve lower borrowing costs.
“Demand is strong in part because the state has cut back dramatically on GO borrowing,” Alan Schankel, managing director at Janney Capital Markets, said in a report Wednesday.
California state issuance dropped 53% to $4.9 billion in 2011, from $10.5 billion in 2010. The state set a municipal market record by selling more than $23 billion in 2009. Last year it was only the third-largest issuer in the country.
The downward trend is expected to continue, with state budget plans calling for the issuance of about $5.2 billion of new-money GO debt in 2012, though the low-rate environment may encourage refundings.
On Monday, the state’s Legislative Analyst’s Office said the governor’s new budget may overestimate revenue by as much as $6.5 billion for the two-year period through the end of fiscal 2013.
Even Facebook can’t help the LAO paint a prettier picture of the state’s revenues.
Facebook Inc., based in Palo Alto, Calif., has filed for an initial public offering this year, a transaction expected to generate about $10 billion for the social network while turning hundreds of its employees into stock market millionaires — or billionaires in the case of founder Mark Zuckerberg — with taxable capital gains.
The LAO report projects a $2 billion bump from the Facebook IPO, but noted that the impact only reduces the expected budget shortfall. Last week, the state held an extra $1 billion revenue anticipation note sale in an effort to buffer its cash on hand. The notes were privately placed with Barclays and JPMorgan.
State Controller John Chiang warned lawmakers in January that California would run out of cash by late February unless it adopted $3.3 billion of short-term cash management measures, which also include payment deferrals and internal borrowing.
But the differences between the Department of Finance’s projections and the LAO’s, which stem mainly from how they track capital gains taxes, make it harder to predict the exact size of the deficit, which the governor has pegged at $9.2 billion in his $92.5 billion spending plan proposed in January.
Last year, the state started the year with a $26 billion hole.
If the LAO is correct, it could mean further cuts.
As it stands, Brown’s budget plan leans on a ballot initiative that would raise $6.9 billion by temporarily raising sales taxes and income taxes on the wealthy.
Voters will be asked to approve that measure in November, though the picture may be clouded by competing tax measures put forth independently.
The budget for the years starting July 1 would also cuts $4.2 billion, mostly from social services.
If the voters reject the taxes, state spending for schools, universities and community colleges would be cut by more than $5 billion.
Forecasts will likely be clearer in May when the governor releases a revised budget proposal, an annual rite in the California budget processs. By then April tax receipts will paint a better picture of future revenues.
Standard & Poor’s helped the improve the view of the state’s credit last month when it revised the outlook on its A-minus rating for California to positive from stable. It said there is a one in three chance it could raise the state’s rating in the next two years.
“Importantly, we see a shift toward an improved budget structure and a reduced risk of very late budget adoption, which we view as beneficial to the state’s credit quality over the medium term,” S&P analyst Gabriel Petek said in a report released Monday.
The state passed its first on-time budget in five years last June.
Fitch Ratings also has California as the lowest rated state at A-minus but with a stable outlook. Moody’s rates California A1, two notches higher, with a stable outlook.
“The state still has a way to go towards fixing its structural budget,” said Fitch California analyst Douglas Offerman. “It is important to note that the state has a lot of leftover issues from the last decade when it used one-measures.”
The one-time measures are part of what Brown calls the state’s “wall of debt,” which he has been trying to reduce in his budgets.
California has another multibillon dollar GO deal slated in April. On that transaction, the joint senior managers are Citi, Merrill Lynch Bank of America and Morgan Stanley.
