Investor demand for new California debt weakens as muni bond sell-off continues


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The turmoil in the municipal bond market over the last week may have scared some investors away from California’s offering of $10 billion in short-term notes.

The state said it took in a total of $5.89 billion in orders for the notes from individual investors on Monday and Tuesday.


That’s a big chunk of change, but it was less than the $6.64 billion in orders the state got from individual investors when it sold $8.8-billion in similar securities in September 2009.

The tax-free interest rates California is offering on the new notes are the same as what it paid in 2009: a projected 1.25% annualized yield on the series maturing May 25, 2011 and 1.5% on the series maturing June 28. Those are well above the rates investors can earn on most short-term securities.

The so-called revenue anticipation notes, or RANs, bring the state some of the cash it needs to pay bills until expected tax revenue arrives later in the fiscal year, which ends June 30.

“We launched this sale in some pretty rough waters,” said Tom Dresslar, a spokesman for Treasurer Bill Lockyer. “Given the market conditions we’re pleased with the retail demand.”

But the state still needs institutional investors, such as money market funds, to buy the rest of the deal. Those investors will put in their orders on Wednesday. The final yields on the notes could be higher than the state has estimated if the institutions demand more of a return to take on the state’s debt.

The mood in the muni market didn’t improve on Tuesday: Market yields on many bonds continued to soar as prices fell, reflecting investors’ broad retreat from the market.

One industry index shows the severity of the sell-off: The annualized yield to maturity on the Bond Buyer index of 40 long-term munis nationwide jumped to 5.35% on Tuesday, up from 5.24% on Monday and the highest since March. The yield has surged from 4.86% in mid-October.


Another measure of the sell-off: The share price of the Franklin California Tax-Free Income fund, one of the biggest muni funds, fell 1.3% to $6.92 on Tuesday, the sixth straight drop and the biggest one-day loss since bond markets were melting down in the financial crisis two years ago.
The fund’s share price has fallen 3.9% just since Oct. 29.

Some closed-end muni funds, which often use borrowed money as part of their investment strategy, have suffered much bigger losses. Shares of the Pimco California Municipal Income fund plummeted 14% from Nov. 8 through Monday. The fund stabilized on Tuesday, rising 15 cents, or 1.2%, to $12.17 a share.

What has gone wrong for munis? The market has been slammed by the sudden convergence of several bearish trends, including rising U.S. Treasury bond yields (which drive up interest rates in general), a glut of new bonds (besides what California is offering), and ongoing concerns about the health of state and local finances.

And one more: uncertainty over whether Congress will extend the Build America Bond program, which for two years has allowed states and municipalities to issue taxable debt subsidized by Uncle Sam. That has reduced the supply of conventional tax-free muni bonds, helping to keep yields low.

But if the program isn’t extended beyond its Dec. 31 expiration, issuers would be forced to ramp up borrowing in the tax-free market in 2011 -- potentially creating more supply problems.

California, with unfortunate timing thanks to the Legislature’s three-month delay on this year’s budget, plans to sell $2 billion in Build America Bonds on Thursday, and $1.75 billion of conventional tax-free bonds Friday through Tuesday.

It’s a buyer’s market in muni bonds, and that is bad news for taxpayers who will foot the interest bill.


-- Tom Petruno