California's Franklin Templeton Still Betting on the Home Team

It may not look good to be the lowest-rated state in the nation.

But despite California’s still-hefty budget deficit that led to successive downgrades amid much political and fiscal upheaval, the state’s own Franklin Templeton Investments — located in San Mateo — is investing there now more than ever, according to John Wiley, a portfolio manager at the firm.

“If we can capture more California paper, we will,” said Wiley, who, along with co-manager Chris Sperry, recently took over sole management responsibilties for the $13.8 billion Franklin California Tax-Free Income Fund after fund veteran Bernie Schroer retired last month. Wiley and Sperry previously co-managed the fund with Schroer.

Wiley said yield spreads on many California municipal bonds are the most attractive he has seen in over a decade. According to the firm, the yields are so compelling that Sperry has been buying California bonds for Franklin’s national municipal and taxable bond funds.

Although some investors stopped buying California bonds while they awaited a resolution of the state’s fiscal crisis, Wiley and Sperry did not give much credence to the talk of insolvency, Wiley said in a telephone interview.

“There are too many ways to raise revenue in this state, and it’s impossible to believe any governor would allow it to fall into insolvency,” he said.

Earlier this month, California voters approved a $15 billion bond deal that will allow the cash-strapped state to meet almost $14 billion in payments for maturing revenue anticipation notes and warrants, thereby avoiding a near-term crisis.

The deal — which the state is planning to sell in pieces beginning in June — will likely be the largest municipal bond issue in U.S. history.

Passage of the bond measure demonstrated that Gov. Arnold Schwarzenegger could work with the state Legislature on its problems, Wiley said. But his confidence is also based on an uptick in tax receipts and a rebounding economy. The fact that California is a wealthy, diverse state is another important factor, he said.

Standard & Poor’s placed the state on CreditWatch with positive implications following the passage of the economic recovery bond measure earlier this month. It had previously assigned a stable outlook to its BBB rating.

Moody’s Investors Service also recently changed its outlook on its Baa1 rating to stable from negative. Fitch Ratings kept the state’s BBB on negative rating watch following the vote.

Wiley said that he and Sperry have been buying California general obligation bonds in addition to state securities connected to education, transportation, and certain utilities for the five California tax-free funds they co-manage. Although they typically do not avoid entire sectors, Wiley said he is wary of stand-alone credits in health care and housing right now, as it has become difficult to assess their viability.

Wiley expects the $15 billion offering — which will be sold in maturities from nine to 15 years — will be especially attractive to buyers of intermediate bonds. He also pointed out that the planned pledge of a sales tax as added security to the state’s full faith and credit make the credit a strong one and that insurance companies are likely to be among the buyers.

When it comes to his home state, the investment decision is a simple one for Wiley. “We’re not staying away from California paper,” he said.