California launching $2-billion tax-free bond sale
California, with the weakest credit rating among the 50 states, is hoping individual investors will see opportunity in trouble as it tries to sell $2 billion in tax-free bonds this week.
As he has done with previous bond sales, state Treasurer Bill Lockyer is spending money on an ad campaign to lure investors to the general-obligation bonds. Strong demand from individuals would mean fewer bonds left for institutional investors such as mutual funds. If that means the big players have to compete more aggressively for the remainder of the deal, the state might be able to pay a lower overall interest rate to borrow, saving taxpayers cash.
Individual investors in California have long been heavy buyers of muni bonds of state and local governments. But as the state’s finances have deteriorated in recent years, some wealth advisors have shifted a portion of clients’ muni portfolios into higher-quality out-of-state issues for diversification’s sake.
The new bonds Lockyer plans to sell won’t help the state plug its $20-billion budget gap. Rather, the proceeds will be used to finance voter-approved infrastructure projects statewide.
The securities will be offered to individuals Tuesday and Wednesday. Institutional investors will put in orders Thursday, and that’s when the final yields on the bonds will be set.
The state sells its debt via brokerages, so individuals must have an account with a brokerage to place an order, although there are no upfront commission charges to buy. The minimum purchase is $5,000. There’s no guarantee that individuals will get bonds if orders are robust. See Lockyer’s Buy California Bonds website for more details on the offering.
Tax-free muni bond yields nationwide and in California have fallen in recent months, in part because individual-investor demand has remained healthy while the supply of new bonds has dwindled. Instead of issuing tax-free debt, many states and local governments have been raising money via taxable Build America Bonds, which are extremely popular with institutional investors.
Despite California’s fiscal misery, the state is betting that many high-income investors will find the tax-free yields on the bonds too attractive to pass up. Case in point: The seven-year bonds in the deal are expected to pay an annualized tax-free interest rate of about 3.6%, according to preliminary estimates from Wall Street dealers.
For a California couple in the 39.4% combined federal and state income tax bracket -- which starts at taxable income of about $209,000 -- a 3.6% yield exempt from federal and state income tax is the same as earning a fully taxable yield of about 5.9%.
Tax-free muni yields will be worth even more if Congress allows President George W. Bush’s tax cuts to expire as planned Jan. 1.
As for the safety of the state’s bonds amid the still-grim economy, debt holders’ payments are mandated by the California Constitution. Even so, to make investors feel better, Lockyer backed a bill passed by the Legislature last week that gives state finance officials more flexibility in managing short-term cash flows -- the idea being to keep cash levels in the state’s coffers high enough to calm concerns that bondholders’ payments could be delayed by temporary money shortages.
