State to launch muni bond sale

California today will launch a $4.5-billion sale of municipal bonds to finance infrastructure projects, in a deal that will test investors’ recently strong appetite for fixed-rate debt.

It’s California’s first long-term bond offering since April and comes just two weeks after the state sold $8.8 billion in short-term notes.

The California muni bond market has been starved for supply over the last two months, with the result that market yields on long-term tax-free bonds have edged lower nearly every week -- because investors have, in effect, been fighting over what little is available.

This has been a national story with muni bonds and with fixed-income securities in general: Long-term yields have plunged since July as investors have rushed to lock in returns, in part reflecting doubts about the economic recovery.

The annualized tax-free yield on 10-year California general obligation bonds was about 3.5% last week, far below the 5.25% yield investors could have gotten in late June.

Heavy demand for muni bonds nationwide has pulled the Bond Buyer yield index of 20-year general obligation issues down to its lowest level since 1967, at about 3.94%, according to Bloomberg News.

Joe Lee, a muni trader at bond dealer De La Rosa & Co. in Los Angeles, said yields on California munis have dropped to levels that finally have made some potential buyers balk. “People think the market has run too fast here,” he said.

California continues to have the lowest credit ratings of any state (“A” from Standard & Poor’s and “Baa1” from Moody’s Investors Service) because of its still-dicey budget outlook.

But thanks to federal assistance, California and other muni issuers have new borrowing flexibility this year that may work to keep yields relatively depressed.

Although California will borrow $4.5 billion in all, the tax-free bond portion of the deal -- the traditional muni securities that individual investors want -- may total as little as $1.3 billion. The rest of the offering will be in the form of taxable bonds, including up to $2 billion of so-called Build America Bonds.

Under the Build America program, state and local governments borrowing to fund infrastructure projects can issue taxable debt that is subsidized by the federal government. That reduces net interest costs for the borrowers while providing them with new sources of investment demand: pension funds, life insurance companies and others that generally don’t buy tax-free bonds.

With California and other governments issuing more taxable bonds, the supply of tax-free bonds has become much more limited.

When the Los Angeles Unified School District sold about $2 billion of bonds last week to fund building and renovation projects, taxable Build America bonds constituted $1.37 billion of the deal, or more than two-thirds of the total sold.

Individual investors who are interested in the state’s bond offering this week can put in orders today and Wednesday. (You must order via a brokerage, and the minimum order is $5,000. For more information, go to the state treasurer’s website, BuyCaliforniaBonds.com.)

The tax-free bonds -- exempt from state and federal income tax -- will be split among maturities ranging from six to 20 years.

On Monday, the state gave preliminary yield estimates on the bonds that were somewhat higher than market yields in recent days, suggesting that it was hoping to entice strong demand from individuals.

Three examples: The preliminary tax-free yield on the six-year bonds is 2.87%; on the eight-year issue the state quoted 3.42%; and on the 20-year it quoted 4.63%.

But individual investors are at the mercy of institutional investors such as mutual funds, which will submit their bond orders Thursday. That’s when the deal will be priced and the final yields will be set.

If the state garners robust demand from small and large investors alike, it could reduce the final yields.

If individual buyers don’t like the final yields, they can cancel their orders Thursday.

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