California on Monday kicks off about $14 billion of debt sales, hoping that investor desire for yield will outweigh concerns over the US state’s fiscal trouble in a weak market for local government debt.
The Golden State is the starkest example of the financial difficulty facing US local governments. Worries are mounting of a possible rise in defaults or a reassessment of risk in the $2,800 billion municipal bond market, hitherto perceived as a safe place to invest.
California’s plans to sell its debt come just days after Arnold Schwarzenegger, the state governor whose term ends in January, called a special session of the legislature to address a state deficit projected to be more than $25 billion over the next 18 months.
Orders begin on Monday for a $10 billion, two-part sale of so-called revenue anticipation notes (Rans), an annual event that allows California to bridge the gap to its tax season in the spring. The notes, due in May and June, are targeted mostly at individual investors who benefit from tax breaks on so-called “munis.”
Muni bonds generally last week sold off on concerns about shaky finances and the looming end of federal subsidies for the Build America bonds (Babs) program, which has boosted the market since the credit crunch.
The yield on 30-year triple A munis rose 15 bps last week, the largest such rise in about 18 months, according to an index compiled by Municipal Market Advisors.
Republican gains in midterm elections called into doubt an extension of these subsidies, prompting a rush to sell bonds before their expiry at the end of the year. Long-term muni bond yields were also rose in line with US Treasuries.
Rob Novembre, head of municipals at Arbor Research & Trading, said the prospects for the sale would “come down to a question of the right yield”.
Market expectations are for a relatively low yield of 1 percent to 1.5 percent. Some believe the sale will be helped by investor willingness to take more risk in pursuit of higher returns in the current low-rate environment.
Marilyn Cohen, founder of Envision Capital Management, a fixed-income portfolio manager, urged caution for clients who already own a lot of bonds from California, the largest issuer of state debt. “Some of us had the hope that [lawmakers] would really deal with the problems and they didn’t,” she said.
On Thursday, the state is issuing $2 billion of Babs in a sale aimed at institutions and next week it will sell $1.75 billion of tax exempt bonds.