Story first appeared on WSJ.com.
California has long ranked second only to Illinois in the dubious
honor of being the least-loved state among municipal-bond investors.
But since Election Day, some investors have had a change of heart.
On Nov. 6, California voters approved temporary tax increases that
Standard & Poor's estimates will boost the state's revenue by more
than $6 billion over the next several years. The tax rise was a
controversial move in the already high-tax state, but it suddenly made
California's bonds more appealing, market participants said. California
also passed modest pension changes this year.
Meanwhile, Illinois has done little to address its $83 billion
unfunded pension liability. The state had roughly $6 billion in unpaid
bills as of the end of September, according to the state comptroller's
office.
That has separated the two states in the minds of some investors. The
difference in yield, or spread, between the debt of the two
lowest-rated states has increased to its widest point since early March
2011, according to Thomson Reuters Municipal Market Data.
Last week, the yield on 30-year Illinois debt was 0.60 percentage
point above that of similar California debt. As prices fall, yields
rise. The higher the yield, the bigger the perceived risk. On Election
Day, the spread was 0.42 percentage point. In July, it was 0.18
percentage point.
Over the past year, California has done much more than Illinois to
help its fiscal situation. As a consequence, "there appears to be decoupling" in the way the states' bonds are trading.California's
debt has rebounded so much that its yields this month fell below that
of Nevada for the first time since August 2009, according to MMD.
In November, California munis have returned 1.50% through Friday,
according to S&P Dow Jones Indices, compared with 1.43% for
Illinois. For 2012, S&P Municipal Bond California index has returned
9.80%, while the Illinois index has returned 9.78%.
Both states are outperforming the broader muni market, as investors
hunt for extra yield amid rock-bottom rates in markets such as Treasury
bonds. The S&P National AMT-Free Municipal Bond index has returned
1.32% in November and 7.88% so far this year, through Friday.
The passage of the tax increase, under Proposition 30, was the
"catalyst for this rally" in California bonds, said Dan Berger, MMD's
senior market strategist.
Investors are favoring California debt, even though S&P and Fitch
Ratings give the Golden State the lowest rating of all 50 states, at
A-minus, while Illinois is rated a notch higher, at A. Moody's Investors
Service gives Illinois the lowest state rating at A2, while it rates
California a notch higher at A1.
The market is signaling California has a
better chance of getting upgraded, while Illinois may see a downgrade. Director of fixed income at BNY Mellon
Wealth Management, said his firm has bought more California bonds in
light of Proposition 30's passage, while keeping exposure to Illinois
debt steady.
To be sure, California still faces challenges, market participants
say, and the tax increase voters approved this month is only for seven
years, meaning a more permanent solution must be found to mend the
state's budget woes.
Managing director at research advisory
firm Municipal Market Advisors, said investors should be leery of
California's boom-and-bust economy, as well as its more tenuous cash
position. The state's current cash deficit stands at $24.7 billion,
covered with $14.7 billion of internal borrowing, and a $10 billion
short-term debt deal from earlier this year, he said.
