California's debt problems escalate as state issues $3 billion in IOUs; market little moved

By Aaron Hochman-Zimmerman and Sheri Kasprzak

New York, July 2 - As the municipals market prepared for a three-day weekend, the state of California announced that it will begin issuing more than $3 billion in IOUs to taxpayers, vendors, local governments and others, according to the state treasurer's office. The move comes as the deadline expired for a balanced budget.

"The state will pay 3.75% annual interest when it redeems the IOUs," said Tom Dresslar, spokesman for treasurer Bill Lockyer's office Thursday.

"The State Pooled Money Investment Board - chaired by state treasurer Bill Lockyer - set the interest rate today [Thursday]. The state will redeem the IOUs no later than Oct. 2, 2009...But under emergency legislation signed into law Wednesday by the governor, the IOUs can be redeemed before Oct. 2, if the state determines it has sufficient cash. If the IOUs are redeemed early, the state will pay the interest accrued up to that time, instead of the full interest rate that would be due Oct. 2."

Some banks may accept the IOUs from recipients before they are eligible for redemption. Assuming a bank accepts an IOU before it is eligible for redemption, the bank, not the recipient, will receive the interest when the bank presents the IOUs for redemption to the treasurer's office. If the bank doesn't accept the IOUs before they're eligible for redemption or if the recipient decides to collect interest rather than their bank, the recipient can hold the IOU, present it directly to the treasurer's office for redemption and receive the interest.

So far, Dresslar said in a statement, Bank of America and Wells Fargo Brokerage Services have agreed to accept IOUs from their customers before they're eligible to be redeemed. The banks said they would accept IOUs from customers through July 10.

Too little, too late?

As previously reported, California governor Arnold Schwarzenegger declared an economic state of emergency Tuesday to force the legislature to solve the $26.3 billion budget crisis. The decision to wait that long has been criticized by at least one market insider as being "too little, too late."

"Here we are in the new fiscal year, and they're just now knuckling down and doing something. This should have been done weeks, months ago," said the sellside source reached Thursday morning.

The state has been forced to issue IOUs to their debtors and local agencies.

The budget crisis, said a trader on Wednesday, may contaminate even strong California names in the municipals market. For example, the city of Pasadena, which is one of the state's premier names, was having trouble in the secondary market, the trader said.

Despite the budget problems in the Golden State, investors were still seen buying California bonds, said one trader.

"Bill Gross [Pimco LLC co-chief investment officer, who is known as the Bond King] came out and said you should buy Cal," the trader said.

California 5% bonds due 2030 were spotted at 6.23%, while 5.25% bonds due 2026 were seen at 5.97%.

Market closes mostly unchanged

Looking to the broader municipal market Thursday, insiders said the market was unchanged to slightly weaker as market insiders prepared to leave their desks for the Independence Day holiday.

One trader said he felt the market was relatively unmoved ahead of the holiday with very light trading action. Another said the market might have been a touch weaker.

"There really hasn't been much of a session," a senior trader said.

Municipal bonds became "fair-valued in the last week," he said.

Volumes may have seemed slight at a casual glance, but "there was some sneaky buying today," he said on Thursday.

Florida State Board of Education bonds were some of the credits which "started to disappear," he said. The 4.75% bonds due 2037 were bought at 4.937%.

"AA stuff" and essential service revenue bonds are receiving attention, he said, after general obligation bonds have somewhat run their course.

There has been a reluctance to buy general obligations in favor of a slightly better yield, although buyers are still mindful of credit, he said.

The water and sewer bonds bring dedicated revenue and "it makes you more comfortable," he said.

L.A. deal coming

Despite the troubles in California, the coming week's primary action will be led by a $1.039 billion sale from the city of Los Angeles. The city is expected to bring to market tax and revenue anticipation notes (MIG1/SP-1+/F1+) on Thursday.

Goldman Sachs & Co. will sell the notes, which are due June 30, 2010.

Proceeds will provide effective cash-flow management for revenues and expenditures.

Also ahead out of the California is $177 million in series 2009-2010 tax and revenue anticipation notes (MIG1/SP-1+/) from the county of Santa Clara. The county plans to price the notes on Wednesday.

The notes (MIG1/SP-1+/), which are due June 30, 2010, will be sold competitively with KNN Public Finance as the financial adviser.

Proceeds will pay for general expenses ahead of the collection of certain taxes and revenues.

Nebraska Public Power bonds

In other upcoming deals, the Public Power Generation Agency of Nebraska is set to sell $211.165 million in series 2009 revenue bonds, according to a preliminary official statement.

The sale includes $22.91 million in series 2009A Whelan Energy Center Unit 2 revenue bonds and $188.255 million in series 2009B Whelan Energy Center Unit 2 revenue Build America Bonds.

Goldman Sachs is the lead manager.

The 2009A bonds are due 2012 to 2017. The 2009B bonds are due 2041.

Proceeds will be used to construct a coal-fired electric generating unit.

Secondary mostly unmoved

Moving to Thursday's secondary action, traders said the market remained mostly unchanged ahead of the holiday weekend.

Among the light trading action were refunding revenue bonds from the Lower Colorado River Authority. The 5.25% 2029 bonds were seen at 5.07% Thursday.

Elsewhere, the North Fort Bend Water Authority of Texas saw some movement from its water revenue bonds. The 5.25% 2034s were seen trading at 5.001%.

Also traded Thursday were certificates of participation from Cabarrus County, N.C. The 4.375% 2021s were seen at 4.226%.

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