State to Sell $1 Billion in General Obligation Bonds

California will sell $1 billion in general obligation bonds Wednesday, the first such debt offering since the state last month reported a dramatic improvement in its 2005-06 budget outlook.

The tax-free interest rates that investors demand on the bonds may show whether Wall Street is taking a more optimistic view of the state’s longer-term finances.

On Monday, a municipal bond analyst at brokerage UBS Financial Services predicted that major credit rating firms soon would lift California’s bond rating, which is tied with Louisiana’s as the nation’s lowest.

In Sacramento, nonpartisan Legislative Analyst Elizabeth G. Hill reported Nov. 16 that a surge in tax receipts from the growing economy meant the state was on track to end its fiscal year in June with a budget reserve of $5.2 billion.

Matt Fabian, a muni credit analyst at UBS, said in a research report: “We believe that these revenue estimates should set the stage for additional state rating upgrades in the next few months. We see little reason for the rating agencies to wait much longer before acting.”

Rating firms Moody’s Investors Service and Fitch Ratings both raised their ratings on the state’s debt one notch in July. Moody’s rates California A2. Fitch’s rating is A. Standard & Poor’s also rates the state A.

Although an A grade might sound high, most states get better grades. The top grade is AAA.

The higher a state’s credit rating, the lower the interest rates it pays to borrow.

But many municipal experts say California, by virtue of the inherent strength of its economy, already is paying lower bond yields than its credit ratings would imply.

On Monday, the market interest rate, or yield, on a 20-year California general obligation bond was 4.56%, according to Bloomberg News. A 10-year California bond paid 4.18%.

Because those yields are exempt from state and federal income taxes, the true return can be much higher, depending on an investor’s tax bracket.