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Prices of State Bonds Slide on Concern Over Energy Crisis

Investing: The nervousness could add millions to California's borrowing costs when it tries to sell $20 billion in new issues.


Prices for bonds sold by the state of California are sliding, as concerns that the recent bankruptcy filing by Pacific Gas & Electric, the state's largest utility, will further complicate the state's ongoing energy crisis.

The nervousness in the California bond market could add millions to the state's borrowing costs when it tries to sell nearly $20 billion worth of new bonds later this year.

"I don't think we've seen the worst of this yet," said Mary Beth Syal, a municipal bond portfolio manager at Payden & Rygel, a Los Angeles bond firm with $2 billion of municipal bonds.

It's important to note that analysts aren't predicting the state will miss interest payments on outstanding bonds, or that owners of these bonds won't receive the full face value when their securities reach maturity. A decline in the price of existing bonds affects bondholders only if the securities are sold before maturity.

However, the ongoing energy crisis could hurt the state's long-term financial health, and that's what makes bond traders nervous.

In the last three months, prices for the state's general obligation bonds have dropped an average of $15 to $20 on a $1,000 bond that matures in 10 years, said traders. Nearly half of that decline has occurred this week, traders said.

Although most of that was due to the state's energy woes, it didn't help that U.S. Treasury bonds on Tuesday suffered their worst one-day loss since Jan. 3 as investors dumped bonds because of a stock market rally.

Large institutions, such as insurance companies, that own billions of dollars of California's general obligation bonds reportedly were trying to sell large blocks of bonds on Tuesday but finding no bidders, bond traders said.

"Any bond where the state of California is on the hook is being affected," said Robert Gore, a longtime municipal bond manager and partner with Crowell Weedon & Co., a Los Angeles investment firm.

"The whole energy thing has been handled so poorly, it worries the market. The problem is that they aren't talking anything that looks like a solution," Gore said.

The state of California sells bonds to fund schools, roads and other state projects. The state has $19 billion of general obligation debt outstanding and $28 billion of other debt, according to the California Debt and Investment Advisory Commission, a state debt tracker.

Municipalities and other agencies in the state sell bonds as well, but those securities are not being as adversely affected, traders said.

Dropping bond prices mean the state will have to pay higher interest rates to entice investors--both individuals and institutions--to buy future debt issues.

It also means the state will have to pay more--it's unclear how many millions of dollars more--if it goes forward with plans to sell nearly $20 billion of bonds this year, a near-record amount.

Those bonds include about $7 billion in revenue bonds to finance the state's proposed purchase of electric power transmission lines from California's beleaguered utility companies.

The new bonds are all revenue bonds, which means they will be repaid by charges on electricity bills, not by tax dollars from the state's general fund. But the large amount of bonds flooding the market, starting in late May or June, is expected to unsettle bond traders and push them to demand higher interest rates.

"How much is the market going to charge them to sell these bonds? It's complicated, and we're in a pretty dicey period where its billions of dollars everywhere you look," said Mary Miller, assistant director of fixed income at T. Rowe Price, which operates a $230-million California municipal bond fund.

Credit rating agencies, including Moody's Investors Service on Friday, put California on "negative credit watch" because of concerns about the state's general fund, especially that the state has not yet been reimbursed for about $3 billion in electricity purchases it has made since January. PG&E's surprise Chapter 11 bankruptcy filing on Friday unnerved some traders who see no end in sight to the state's energy woes.

Calls to the state treasurer's office were not returned.

The decline in prices this year comes after a strong municipal bond market last year. Returns were especially good for muni investors in California, which had to do with both demand and a lack of supply.

In fact, the average California long-term muni mutual fund produced a total return (interest earned plus principal appreciation) of 12.9% in 2000, according to Morningstar, a data-tracking service. Given that the interest paid on municipal bonds is exempt from federal taxes, that return is more like 15% or 16%, depending on an investor's tax bracket.

But in the first quarter of this year, the California market had weakened relative to munis nationwide. The average California municipal bond fund produced a total return of 1.3% in the quarter, below the 1.9% average total return of muni bond funds as a group.

Still, in the long run, the bond-price drop shouldn't hurt the many retirees who buy municipal bonds as a tax shelter, said financial planners.

Investors who own individual bonds and hold them until maturity will be fine, and investors in mutual funds will make up for lagging returns eventually if they hold for the long-term, said Preston Caves, a financial planner in Manhattan Beach.

"These burps are going to happen in any market," he said. "The key is asset allocation."

Institutional investors might eventually see the decline in bond prices as a buying opportunity, some traders said.

"When I see these bonds trading at back where they were during the recession, you start salivating," Syal said. "But we don't want to buy yet if it's going to get worse."

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