As California works to repair its budget, the state treasury is ramping up its effort to reach an unusual type of bond investor: regular people.
A new bill, supported by state Treasurer Bill Lockyer, would allow the state to issue $25 bonds, dropping the minimum bond size from $1,000 and broadening the field of potential buyers of California debt. For the state that bears the worst Standard & Poor's credit rating of all 50 states, the move could potentially lower borrowing costs, and it would give the government a wider set of buyers to turn to if institutional investors -- banks and funds -- turn up their noses.
Nationwide, states recognize the ability to sell debt to mom and pop investors as a useful tool, as institutional buyers prove fickle in the wake of the financial crisis. While it may be more complicated for states to manage a host of smaller bonds rather than a few large ones, issuing so-called retail bonds can give governments an edge in negotiations with the bigger buyers. As a result, governments may face lower costs as they borrow money to pave roads, repair bridges, and build hospitals and parks.
Other states have made similar forays into the retail market. Vermont devoted an entire bond sale to retail investors in 2009, when the financial crisis raised concerns about institutional buyers, The Bond Buyer reported. Massachusetts announced Monday it will sell $1,000 bonds this coming weekend, products a fifth as large as its typical $5,000 minimum size.
"The muni market as it stands right now is more reliant on individual investors than ever," said Matt Fabian, managing director of the Concord, Mass.-based Municipal Market Advisors. "The institutional investors that we've had over the past few years are concerned about credit quality, or they're concerned about liquidity, or they simply don't have the economics to buy these things."
It's been a rough few years for state and local governments, as concerns about credit quality have sent bond interest rates soaring. The difference, or spread, between the yield on an index of municipal bonds and the yield on ultra-safe U.S. Treasury securities nearly doubled from September 2008 through the end of that year, after the financial crisis struck, according to data from Bloomberg. Starting in the fall of 2010, warnings about local government defaults from analyst Meredith Whitney helped fuel widespread anxiety, and investors have been pulling money from municipal mutual funds.
History has proven state and local government defaults to be extremely rare, but that apparently hasn't quelled investors' fears. Last year, the Standard & Poor's/Investortools Municipal Bond Index, which includes $1.27 trillion of municipal debt outstanding, logged just $2.65 billion in bond defaults, according to a January report from S&P. That constituted an 8.6 percent decline from 2009. State budgets are even more secure, and a state hasn't defaulted on its debt since the Great Depression.
Compared to other states, California is regarded especially poorly. Its debt has a A- rating from Standard & Poor's, six notches below the company's highest grade. No other state has a rating that low.
While attracting retail investors won't solve California's debt problems, it might provide one small part of a solution. Since Lockyer assumed office in 2007, he has made an effort to appeal to retail investors, with ad campaigns and a website that explains how to invest in state bonds. This new bill, the latest push in a long-term strategy, awaits a vote by the state Assembly.
From California's perspective, tapping retail investors can help lower borrowing costs. Retail investors enjoy a special "early order period" in which they can buy bonds before institutions, according to the state Treasury's bond website. If these investors buy bonds at a relatively low yield, the state can use that as a bargaining chip to win lower yield from institutions.
"There's some notion out there, I guess because of current market conditions, that this is some kind of move of desperation -- which is B.S.," said Tom Dresslar, a spokesman for the Treasury. "To the extent that you maximize retail investment, it puts you in a better negotiating position when you go to the institutional folks. You can knock off a few basis points, or what have you, before the final price is set."
California's cost of borrowing has been gradually falling. The secondary market spread between yields of the state's debt and an index of highly rated bonds declined by 19 basis points, or nearly a fifth of a percentage point, over the six months that ended May 6, according to data provided by the California Treasury.
Massachusetts' new program, Build Mass Bonds, will offer $1,000 bonds to individual investors during a special order period this coming weekend. The state hasn't offered a bond that small in more than two decades, according to a release.
The Massachusetts Treasury invoked a sentimental sense of allegiance to the state.
"These bonds are about more than interest rates and maturity dates," state Treasurer Steven Grossman said in a release. "They’re about giving more people an opportunity to invest in our shared infrastructure, the roads, bridges, parks and campuses that they utilize on a daily basis."
The yield earned on such bonds is exempt from federal and state taxes, making them a particularly good deal for Massachusetts residents. Mom and pop investors aren't as concerned about the arcane details of a state's finances as institutional investors are, Fabian, the bond advisor, said. In retail investors' view, the most important considerations are likely a tax-exempt income stream and the promise that the bond will be repaid.
Dresslar downplayed the importance of patriotic sentiment in these investments.
"We don't have any illusions that an investor who thinks California sucks budget-wise and is a bad investment is going to allow some kind of patriotic feeling to overcome those qualms," he said.
"Bottom line is: California is a safe investment," he added. "They wouldn't buy our bonds if they thought they wouldn't get their money back."
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