Articles

California’s Bond Offerings Call For A Careful Look By Investors

Alan Remedios

March 15, 2010

The previous economic downturn has helped to create a deficit in the 2010/2011 California budget and has severely weakened the state's financial position. With a structural deficit of $19 billion facing the state, the Legislature is in the process of evaluating how best to balance the budget through their primary three levers - expenditure reductions, revenue enhancements and internal borrowing.

The state has been successful in issuing both tax-free and taxable fixed income bonds in the marketplace. Additionally, it was successful in selling short-term financing notes in 2009 despite the significant headwinds resulting from the fiscal and credit crisis. Importantly, the state also issued (very successfully) Build America Bonds at a preferential rate and is looking to this market again in 2010.

For bond investors, who are left to ponder the viability for California securities, we offer the following key tenets for consideration. Notably, an analysis of the state's general fund (which secures California State General Obligations (GO's), is of primary importance, since this is directly impacted by the state of the budget.

California state GO's are backed by the full faith and credit of the state. Re-paying the debt on these GO's are second only to public school funding.

Although the financial condition of the state is far from perfect, it appears that California is setting the stage for a long-term solution to the current budgetary shortfall. According to the state's Legislative Analyst's Office (LAO) recent Overview of the Governor's Budget report dated 1/12/10, a multi-year approach combining a mix of one-time and ongoing solutions is necessary to shrink the structural deficit.

In the meantime, the interest payments to bond holders of CA GO's should remain well protected given the above analysis. That being said, there could be "headline" risk associated with the issue and commensurate price volatility as the state slowly recovers and deals with challenges from the many competing forces for a finite sum of funds. It appears that the risk/reward tradeoff is appropriate for owning the state's credit; we are already fully positioned in California general fund related debt and not overweighting at this juncture.

February 2010 Fixed Income Commentary
Municipal Bond Investor's Update

« Back to Article Index