Reaction to State Bonds Enthusiastic

Investors reacted with enthusiasm Monday in signing up to buy approximately $1.5 billion worth of California deficit bonds at the start of one of the biggest municipal securities sales in U.S. history.

Confident that the financial markets would embrace the bonds, state officials had increased the size of the offering by $870 million to nearly $7.9 billion. Most of the bonds will be sold to institutional investors on Wednesday.

Interim Chief Deputy State Treasurer Barbara Lloyd said the initial demand from individual investors was “pretty amazing.”

Lloyd said state officials were “obviously pleased” by the volume of orders received on the first day of a two-day retail sales period that ends today.

Officials had hoped for strong early numbers, she said. “That’s the right kind of start to the sale of these bonds.”

Orders from individuals in California get priority ahead of institutional investors such as mutual and pension funds that represent many buyers.

The so-called economic recovery bonds being sold this week are the first installment of up to $15 billion in long-term debt authorized when California voters approved Proposition 57 on March 2.

The state plans to sell almost $12.3 billion worth of deficit bonds by early next month, mostly to refinance short-term borrowing that comes due in mid to late June.

George von Zedlitz, senior vice president of the fixed income division at the Charles Schwab brokerage, said “there was quite a bit of demand” over the weekend.

When brokers came to work Monday, he said, “there were a lot of messages to return. The phones have been busy all day.”

Von Zedlitz said there has been a lot of publicity about the long-term bonds, which Gov. Arnold Schwarzenegger encouraged state voters to support as a way to help California recover from the worst budget crisis in more than a decade.

“There has been a certain buzz about the future of California” after Schwarzenegger won passage of the bonds, he said.

Stephen Kelleher, managing director at RBC Dain Rauscher, one of the many firms involved in underwriting the deal, said there was excitement about the bond offering.

“It certainly was the most publicized municipal bond referendum I’ve ever seen,” Kelleher said.

The amount of debt the state is offering is so large, Kelleher said it could exert an upward influence on interest rates in the national municipal bond market.

The state is offering bonds at various maturities ranging from one year to 19.

Lloyd, the chief deputy treasurer, said the yield on the issue maturing in July 2005 was likely to be close to 1.9%. Bonds that mature in 2017 will yield close to 4.5%.

But the interest earned is exempt from state and federal income taxes, meaning that an investor would have to get considerably more from a taxable investment to achieve the same after-tax return.

Lloyd said the treasurer’s office decided late last week to increase the amount of bonds being sold because interest rates had been rising and demand for the bonds appeared strong.

Altogether, the state now plans to sell $6.87 billion at fixed interest rates, and another $1 billion will be sold with a fixed rate for the first three or four years.

Investors will be watching today’s Federal Reserve Board meeting for any sign that the central bank intends to raise interest rates, which could require the state to offer higher bond yields.

Officials in Sacramento were heartened last month when the two largest Wall Street rating agencies assigned significantly better grades to the deficit bonds, which are secured by a dedicated stream of sales taxes. In contrast, California’s general obligation debt -- backed by general revenues -- carries the lowest rating of any state because of an ongoing budget deficit.