Market Close: Cal. GOs Hit Headwinds Despite Improved Outlook

After what appeared to be strong retail demand for California general obligation bonds in the primary market Tuesday and Wednesday, the state faced headwinds with institutional buyers Thursday.

Yields on over $2 billion of California GOs were increased as much as 15 basis points from the retail scale when prices for institutions  Thursday, despite a recent one notch upgrade to A by Standard & Poor’s and a revised outlook to positive from stable by Fitch Ratings.

After a two-day retail order period, JPMorgan priced for institutions $2.15 billion of California various purpose GOs later Thursday. The bonds are rated A1 by Moody’s Investors Service, A by Standard & Poor’s, and A-minus by Fitch Ratings.

In institutional pricing, yields on the first series, $1.04 billion of various purpose GOs, ranged from 0.89% with 2% and 3% coupons in a split 2017 maturity to 4.13% with a 4% coupon and 3.89% with a 5% coupon in a split 2043 maturity. The bonds are callable at par in 2023. Yields were increased 15 basis points on the 2038 maturity and 13 basis points on the 2043 maturity. This comes after yields on the second retail order period were increased as much as two basis points from the first retail pricing.

Yields on the second series, $1.11 billion of various purpose GO refunding bonds, ranged from 0.89% with a 5% coupon in 2017 to 3.81% with a 4% coupon and 3.54% with a 5% coupon in a split 2033 maturity. The bonds are callable at par in 2023. Yields were increased between five and 15 basis points on maturities outside 2024 and as much as three basis points on maturities inside 2023. That comes after yields were increased as much as two basis points in the second retail pricing from the first retail order period.

“The cuts on the California bonds are what is really going on in the general market,” a San Francisco trader said. “It just feels like a bad time to be bringing a deal.”

Recently, an improved view of the state’s finances, after years of being at the bottom of the barrel of state ratings, combined with spread compression throughout the municipal market, has helped to significantly tighten spreads compared with top-rated debt. But that tightening has also helped pushed some investors out of the deal this time around.

“The market has gotten a bit more comfortable with the improvement of the state’s credit quality,” said Michael Johnson, co-chief investment officer at Gurtin Fixed Income Management in Solana Beach, Calif. “While the yields are a bit below what we would want to see to participate, I still think it is a place where you can find a little bit of yield relative to very tight yield spreads across the muni market.”

California spreads tightened 10 basis points to 36 for its five-year bond on the first day of the retail sale compared to the first day of its retail GO sale in September.

The 10-year bond moved eight basis points to 58 from 66, and the 30-year 13 basis points to 64 from 77, compared to the Municipal Market Data triple-A scale.

In September, California sold around two-thirds of its $1.75 billion deal to retail, even increasing the amount to meet demand. However, tighter spreads don’t necessarily mean lower yields.

Preliminary tax-exempt yields quoted to retail investors rose to 2.54% for a 10-year bonds this week from 2.45% last fall and 30-year yields jumped to 4% from 3.72%.

“We knew going in that it was going to be more of a challenge this time around with retail; that said, we are pleased with the results,” said Tom Dresslar, spokesman for Treasurer Bill Lockyer.

Other traders said they were pleased with retail demand. “Retail came in strong with $800 million in orders,” a Chicago trader said.

The state sold 37% of the total $2.16 billion of tax exempt offering to retail investors on Tuesday and Wednesday, according to the State Treasurer’s Office. But the $795.4 million bought by retail totaled 89.4% of the $888.9 million of bonds that were offered to retail.

And the California deal took all the attention, with the rest of the market taking a backseat. “With California institutional pricing, the secondary market has gotten very quiet,” the Chicago trader said. He added that more outflows this week could put additional pressure on the market.

Outside the California deal, the overall market felt weaker on Thursday, too. “Even the North Carolina deal saw cuts,” the San Francisco trader said, referring to the $112 million deal from Durham County, N.C.

In the secondary, the market felt flat to weaker. “We are looking at the shorter call stuff within seven years and it’s grudgingly weaker by a few basis points,” he added, “Though it should be a lot weaker. We are seeing the same bonds day in and day out cut one to two basis points every day. They should just cut seven basis points and sell. But today it’s just a couple basis points weaker.”

On Thursday, municipal bond market scales ended weaker for the fourth session this week.

Yields on the Municipal Market Data triple-A GO scaled ended as much as four basis points higher. The 10-year yield rose one basis points to 2.00% while the 30-year yield increased three basis points to 3.14%. The two-year finished flat at 0.31% for the 18th consecutive session.

Yields on the Municipal Market Advisors 5% coupon triple-A benchmark scale climbed as much as five basis points. The 10-year yield jumped two basis points to 2.03% while the 30-year yield spiked up four basis points to 3.22%. The two-year held at 0.33% for the 13th session.

Treasuries ended weaker Thursday. The benchmark 10-year yield rose one basis point to 2.04% while the 30-year yield jumped two basis points to 3.24%. The two-year finished steady at 0.27%.

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