Retail buyers aren't likely to show up for California's $2.2 billion sale

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LOS ANGELES — When California prices a $2.2 billion all taxable deal Tuesday it will appeal to a different set of buyers than a similarly sized deal the state sold last month.

California did well with retail buyers during its March 8 sale of $2.18 billion in tax-exempt general obligation bonds. During that sale, it experienced the largest retail demand for its bonds in five years, according to the state treasurer’s office.

Retail buyers aren’t likely to show up when the state prices $2.2 billion in federally taxable general obligation bonds next week to refund old debt and provide funding for 2,600 projects including high-speed rail, stem cell research and affordable housing.

Institutional bond funds, not retail, are the bonds’ likely buyers, said Marilyn Cohen, founder of Envision Capital Management.

“I wouldn’t buy them," Cohen said. "You don’t have the liquidity you do with corporate bonds and they aren’t sensitive to interest rate moves when rates go down and prices go up.”

Cohen said she holds just a smattering of taxable munis in a few accounts.

The last time retail investors were excited about taxables is when Build America Bonds were sold in 2009; and that's because people were reassured that they would be backed by the federal government, Cohen said.

The elimination of advance refundings on tax exempt bonds in December’s tax overhaul leaves the state few options for refinancing the 2009 bonds outside of selling them as taxables, said Tim Schaefer, California’s deputy treasurer for public finance.

“It leaves us in a position we couldn’t get at them for another year to refund, because of the elimination of advance refunding – and rates are on the rise,” Schaefer said. “Selling taxables offers a way to chip away at it.”

The $947 million in new money will fund some projects and take out commercial paper. The remaining $1.2 billion would be used to advance refund a portion of $5.5 billion in bonds sold April 2009 at 6.5% interest rates that would not be callable until next year.

“Even though the bonds are taxable, it’s still economical to do it this way, because the rates are still so much lower than they were in 2009,” Schaefer said.

J.P. Morgan and Citigroup are joint book-runners on the deal, which includes 26 bankers. Orrick Herrington & Sutcliffe LLP as bond counsel and Public Resources Advisory Group as municipal advisor round out the finance team.

The bonds are rated AA-minus by S&P Global and Fitch Ratings and Aa3 by Moody’s Investors Service.

The well-known credit is also no stranger to the taxable market.

“The taxable markets treat California very well,” Schaefer said. “We were a big issuer of Build America Bonds and are a regular and rhythmic issuer of taxables.”

Though retail won't be a factor, U.S. insurance companies and foreign investors should fill the gap.

“U.S.-based insurance companies, as well as Asian and European investors, have been adding taxable munis over the last several years,” said David Hammer, head of municipal bond portfolio management for PIMCO.

Overseas investors now own about 20% of outstanding taxable muni supply, although expensive currency hedges have slowed demand recently, Hammer said.

Taxable munis offer similar yields to investment-grade corporate bonds with lower demand rates, Hammer said.

Given that the offering documents deal with foreign buyers, it’s clear they are going after international buyers, said Tom Schuette, partner and co-head of investment research and strategy for Gurtin Municipal Bond Management.

Like Cohen, Schuette said Gurtin doesn’t buy many taxables and won’t be a buyer.

Gurtin’s trading desk also isn't seeing any explosion of issuers selling taxables to make up for the lack of advance refundings, Schuette said.

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