Recession-era bond refundings dominate California sales

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LOS ANGELES — California is coming to market for the second time this year with a general obligation bond refunding propelled by the 10-year call date for American Recovery and Reinvestment Act bonds issued in 2009.

Like the $2.29 billion in GOs the state priced March 6, this week's deal is primarily a refunding — with $1.7 billion of the $2.1 billion going to replace maturing debt. In March, $2.01 billion of the $2.29 billion GO sale was a refunding.

A significant portion of the refundings are a result of bonds issued under the American Recovery and Reinvestment Act in 2009 hitting their 10-year call date, said Tim Schaefer, the state’s deputy treasurer of public finance.

Part of the $787 billion economic stimulus signed into law by President Barack Obama on Feb. 17, 2009, through ARRA was aimed at the federal government providing matching funds for “shovel-ready” infrastructure projects. The federal government subsidized the interest on the Build America Bonds created through ARRA, a program that expired in 2010.

During the height of the great recession in 2009, the state “worked off a lot of authorized and unsold bonds to put money into the economy to blunt the effect of the economic contraction,” Schaefer said.

Fast-forwarding to today, those bonds are now redeemable at interest rates much lower than what they were issued at ten years ago, Schaefer said.

Refundings helped make the state the largest issuer in first quarter, Schaefer said.

Morgan Stanley and Goldman Sachs are lead managers on the bonds rated Aa3 by Moody’s Investors Service and AA-minus by Fitch Ratings and S&P Global Ratings. Public Resources Advisory Group is financial advisor. Orrick, Herrington & Sutcliffe is bond counsel.

A retail order period slated for Wednesday will be followed by institutional pricing on Thursday.

Projects funded by the $400 million in new money include high speed rail, water systems and higher education construction.

The state has used advance refundings on the ARRA bonds for the past few several years to lessen the volume coming calleable this year, Schaefer said.

Schaefer would not speak directly to demand expectations on the upcoming deal, but said two factors are weighing in the state’s favor as it rolls out $6.34 billion in bond sales it had planned in March and April. One is the state’s robust economic condition and the second is that as a larger issuer, California attracts buyers who treat the paper like a commodity, he said.

Marilyn Cohen, president of Envision Capital Management, an Encino, California-based fixed income portfolio manager, said though the firm has taken advantage of earlier sales, primarily through the secondary markets, it isn't looking at the upcoming deal, because it is already pretty full on California paper.

She said the deal probably will see robust demand, partly because of interest in California bonds – and partly because of interest in municipal bonds generally, driven by the cap on state and local tax deductions.

Last year's $1.5 trillion tax cut law capped state and local tax deductions at $10,000 a year, making the tax exemption available through munis more valuable in high-tax states such as California, New York and New Jersey, which some say has increased demand for munis ahead of the April 15 tax deadline.

Schaefer said he’s not convinced that there is a direct cause-and-effect relationship between the current investor interest in municipal bonds and the cap on state and local tax deductions.

“We may see a correlation between SALT and interest in California bonds,” Schaefer said. “That seems to be the case, but I’m not willing to make the leap and call it cause and effect. I am not willing to go there yet.”

Cohen said “all that verbiage is real and there has been a food fight between retail and institutional investors to get bonds – and it has been quite a windfall for issuers.”

That, she said, is making municipal bonds in general rich, low yielding and high priced.

“There have been massive fund flows into the municipal market again,” Cohen said. “People are running to municipal bonds, they are not walking.”

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Sell side Primary bond market SALT deduction State of California California