Yields Rise on California Bonds
California bonds were in the spotlight Friday as traders reacted to the blow delivered to the state’s credit rating after the market closed the day before.
Though the market showed no sign of panic -- partly because it was a slow summer Friday -- traders said the Golden State was in a perilous position. Unless legislators move to resolve California’s $38-billion budget shortfall, the state’s credit rating could fall even further, which would certainly spark a sell-off.
New York debt-rating firm Standard & Poor’s late Thursday cut the rating on $26.8 billion in California bonds to BBB -- a three-level downgrade, which brought the state’s bond rating just two notches above “junk” status.
“Much to my surprise, we have not seen a massive amount of selling yet,” said Marilyn Cohen, president of Envision Capital Management in Los Angeles. “But if we go to a junk rating, watch out below.”
The yield on the state’s 10-year general obligation bonds rose Friday to 4.65% from 4.45% the day before, and the yield on the state’s 30-year general obligation bonds rose to 5.48% from 5.35% on Thursday, said Mary Beth Syal, portfolio manager at Payden & Rygel in Los Angeles. A bond’s yield moves in the direction opposite its price.
California municipal bonds are popular with high-income investors in the state seeking a steady stream of income because the interest payments on the bonds are exempt from federal and state income taxes.
Although the higher yields mean the state is likely to pay higher interest rates in future bond issues, investors who currently own California municipal bonds would be affected only if they sold their bonds before they matured.
That’s not the case, however, for mutual funds that invest in California debt. Because mutual funds constantly buy and sell bonds, they often will realize losses on bonds that have fallen in price.
California muni bond mutual funds, which hold $36.1 billion in assets, have posted a total return -- interest plus any price appreciation -- of only 0.7% on average year to date, compared with a total return of 1.2% for the average nationwide muni bond fund, according to Lipper Inc. data. In the last week, California funds are down 1%, compared with a loss of about 0.8% for the category as a whole.
The losses were muted Friday, however. The Franklin California Tax-Free Income Fund, for example, fell 0.1%, and the American Century California Long-Term Tax-Free Fund actually gained 0.1%.
“There hasn’t been a lot of trading, but if anything, I would say there’s more buying at these cheaper levels,” David Anderson, head of the muni bond underwriting desk at Merrill Lynch & Co., told Bloomberg News.
California municipal bonds already are so cheap that they yield more than U.S. Treasury securities with similar maturities, even before taking the tax benefits into account, Syal noted. The yield on the 10-year Treasury note, for instance, closed at 4.17% on Friday.
