California Bonds Get Cool Reception After Downgrade

California’s bonds found few buyers Wednesday as spooked investors worried about a downgrade of the state’s credit rating and its effect on a future flood of energy-related debt.

The day after Standard & Poor’s Corp. cut a key California debt rating from AA to A+, bond traders said sellers were offering slightly lower prices for the state’s general obligation bonds, but it was almost impossible to find buyers for the securities.

“The state of California is a dirty word today,” said Robert Gore, a partner and manager of fixed-income products with Crowell Weedon & Co. “I don’t know where prices are going to settle.”

Bond traders said S&P;’s downgrade was bound to affect other bonds issued by California, including the $10 billion to $14 billion in revenue bonds the state expects to begin selling this summer to help pay off its electricity debts.

Their view is at odds with state Treasurer Phil Angelides’ assertion Tuesday that the revenue bonds would not be hurt by the downgrade, which technically only applies to $25 billion in existing California general obligation bonds and related debt.

“Does the downgrade specifically affect [the energy revenue bonds]? No. Does the downgrade and what it reflects about the credit of the state of California affect the level of all bonds issued in the state? The answer is certainly ‘Yes,’ ” said Steve Galiani, managing director in charge of municipal bonds for Wells Capital Management in San Francisco.

Angelides acknowledged Wednesday that the energy crisis was taking its toll on state bond prices. But he said California’s energy bonds will be rated based on their own merits, and that the Legislature’s current plan for the bonds ensures investors will be repaid.

“It’s human nature to speculate but it’s way too early to say” how the bonds will be rated, Angelides said. “What will matter is how [the bonds] are structured.”

Concern over the energy crisis has already beaten down the price of California bonds--and increased their yields, which move in the opposite direction of bond prices. For 10-year bonds, for example, California general obligation issues yield about 4.75% now, versus about 4.5% for bonds from top-rated states.

Several traders said the market had expected the downgrade, which limited the fallout Wednesday. S&P; said it cut its rating because of concern over the state’s handling of the energy crisis.

California has dipped into its general fund to buy more than $5 billion in electricity so far, and continues to spend more than $54 million a day to keep current flowing to the state’s homes and businesses. Gov. Gray Davis expects the state to spend $15 billion on energy by the year’s end.

The energy bonds, designed to help repay that debt, are California’s best hope against a further downgrade, S&P; analyst David Hitchcock said.

Yet the size of the state’s energy borrowing has spawned anxiety among bond traders and investors. Such a massive flood of debt could depress municipal bond prices and force the state to pay a higher interest rate to induce investors to buy, traders said.

“We have no precedent for this. I think the state is up a creek,” said Marilyn Cohen, a bond expert and president of Envision Capital Management in Los Angeles. “They have no idea what their interest costs are going to be.”

The deal is expected to be the largest municipal bond offering in U.S. history, dwarfing the previous record of a $6.7-billion bond offering by the Long Island Power Authority in 1998.

Angelides said the state hopes to reduce the impact of the bond issue by making 80% of the bonds tax-exempt, with the rest issued at a higher, taxable interest rate. Investors typically demand a higher rate for taxable bonds than for tax-exempt municipal bonds whose interest payments are free from federal and state income taxes.

The state’s plan guarantees investors will be repaid by giving the Public Utilities Commission authority to charge consumers whatever is needed to reimburse the state for its power purchases, Angelides said.

Managers of mutual funds that invest in municipal bonds said that’s the kind of reassurance they’ll need to make the bonds attractive enough for their portfolios. More important, however, will be the price.

“This could be a great opportunity to buy what are going to have to be cheap bonds,” said Dave MacEwen, portfolio manager for American Century Investments in Mountain View, Calif.

Angelides’ office Wednesday also revised its estimates of how much the downgrade will add to California’s borrowing costs. On Tuesday, the treasurer’s office said the state could pay $190 million to $570 million more on the $12 billion in general obligation bonds the state has authorized but not yet issued.

Now the estimated cost is being pegged at about $100 million. Treasury officials said they reduced their estimates because only one of the three major credit agencies had downgraded the state’s debt. The other two, Fitch Inc. and Moody’s Investors Service, have said they may follow suit but have no immediate plans to do so.

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Times staff writer Miguel Bustillo contributed to this report.