California Debt - A Pariah In the Bond Markets

from WSJ:

America's strapped states and cities took another hit Wednesday, with California seeing tepid demand for its latest bond sale and other governments pulling about $700 million worth of borrowing deals this week as investors continued stepping away from the municipal bond market.
The normally staid market has grown volatile the past week, posting its sharpest selloff in nearly two years, as investors demand higher interest rates to buy paper issued by states, cities and counties to finance their operations. Localities have been hammered by a drop in tax revenue amid the downturn—and unlike the federal government, most are barred constitutionally from running deficits.
"The tax-exempt municipal bond market is a cold, cold world right now for issuers and taxpayers," Tom Dresslar, a spokesman for the California State Treasurer, said late Wednesday. He added that the state decided to cancel another $267.3 million bond sale it planned to price next week "in light of market conditions."
California's $10 billion bond sale this week was seen as a test of access for governments to the bond markets, and the middling interest signaled that municipalities could have to pay more to attract investors. The state further jolted the market by delaying the close of the bond sale, citing a lawsuit filed Tuesday that challenges a separate tactic the state is using to raise funds.
"California's timing unfortunately couldn't be worse," said Gary Pollack, head of fixed-income trading and research at Deutsche Bank Private Wealth Management. "This creates a fear among individual investors and probably could hurt the state in terms of paying a higher borrowing cost than if they'd done a deal at a different time."
After pouring billions into municipal bond funds most of the year, investors pulled $115 million out of the funds last week, the Investment Company Institute said Wednesday. That was the first weekly outflow in seven months, ICI said.
The fragility of government finances was also evident in a move by Moody's Investors Service to downgrade the city and county of San Francisco, as well as the city of Philadelphia, and by a request by Hamtramck, a small Michigan city, for permission to file for bankruptcy.
California, facing a projected $25 billion shortfall through June 2012, aimed this week to sell $10 billion in so-called "revenue anticipation" notes. Over three days, it reported total orders of about 60% of that amount, or $6.06 billion, for the securities, according to the Treasurer's office. In September 2009, California sold 75% of a similar offering to retail investors. The remainder of an offering is typically bought by big institutional investors.
Referring to the sale of the notes, Mr. Dresslar said: "We would strongly disagree with characterization that 60% retail demand is tepid. You have to consider the circumstances, and given those circumstances, we believe that 60%-plus retail demand is pretty impressive."
The state surprised the market by extending the bond sale to retail investors for a day, citing a lawsuit filed Tuesday that challenged the sale and lease back of some state properties. If the state can't complete the $1.2 billion sale, its budget hole would be deeper, and state officials said the event was important enough that it needed to inform investors and extend the sale. While the delay added to nervousness, the bond sale was expected to go through.
Michael Pietronico, CEO of Miller Tabak Asset Management, said, "This is not a sign that California is having problems selling its debt in our view."
The short-term notes mature next May and June and yield 1.25% and 1.5%, roughly what California paid a year ago, though higher than other states. "It's still an incredibly low rate, and it's an awful lot of bonds," said Matt Fabian, senior analyst at Municipal Market Advisors.
Buyers of municipal bonds have mixed views on whether the events of the past week are a blip or reflect deeper concerns about the stability of municipal finances.

Rates on long-term municipal debt generally move in synch with long-term U.S. Treasurys, on which rates have risen since the Federal Reserve this month said it would focus its buying on shorter-term bonds.
Also, municipal borrowers, typically active at the end of the year, have been even more aggressive this year in an effort to exploit a subsidized borrowing program devised by the Obama administration called Build America Bonds that many expect to end this year.
At the same time, concerns have been mounting over whether, after the double whammy of 2008 market losses and the economic downturn, municipalities will be able to maintain their reputation for always paying their bondholders.
Average yields on 30-year municipal bonds rose 0.13 percentage point Wednesday to 4.77% and are up roughly 0.5 percentage point in recent weeks. Yields on 5-year bonds rose 0.06 percentage point to 1.58% on Wednesday.
About $700 million worth of bond sales were pulled this week, according to Thomson Reuters. That is roughly 3% of the week's planned sales, according to data from Ipreo. Many of the bond sales were to refinance outstanding debt at lower rates, meaning the governments didn't need the money.
But postponed deals are atypical, market watchers say, and they attribute them to investor demand for higher interest rates amid a glut of bonds as well as the impact of the move in 30-year Treasurys.
Prince George's County, Md., last week postponed until January a $151 million general obligation bond refinancing and a new bond issue of $25 million for public school construction for more-favorable market terms, says Jim Keary, communications director for the county. The deal was supposed to be priced Wednesday. In Arizona, the Tucson Unified School District postponed a refinancing because it couldn't meet its threshold to save at least $1 million with the refinancing of outstanding debt, says Dr. John Carroll, interim superintendent of the school district. "We're just going to have to wait," he says.
Some deals found buyers this week. Houston on Wednesday sold $503.69 million in debt, more than a third of which were Build America Bonds. The city wanted to capitalize on the popular subsidy program amid uncertainty about its extension, says Chris Brown, Houston's chief deputy city controller.
Moody's cited "continued weakness of the city's finances" in its downgrade of Philadelphia, affecting $3.85 billion in outstanding debt. Rob Dubow, the city's finance director, said, "We understand we face fiscal challenges, and we have, but for us the timing is odd, because we feel like we have stabilized." As for San Francisco, the bond rater said the "city ended fiscal 2009 with a balance sheet that was weaker than at any time in the prior ten years."
A spokesman for San Francisco's mayor said the ratings downgrade was "not unexpected" given the challenging economy, and that the city still had a better rating than many other local governments.
The lawsuit that the California Treasurer said prompted the extension of the sale concerned another controversy in municipal finance: the sale of public assets to raise funds. The suit concerned a plan to close an $18 billion budget shortfall in part by selling 11 state-owned properties, and then leasing them back from the new owners, to generate $1.2 billion this fiscal year.