Testimony by Federal Reserve chairman Alan Greenspan reignited credit-tightening fears yesterday, sending municipal bond prices lower with Treasuries.
Dollar bond prices fell 3/8 point, While yields On high-grade issues rose by three to five basis points overall. Trading was active in the morning and light in the afternoon, a municipal analyst said. He cited roughly $300 million in bid lists.
In the debt futures yesterday, the September municipal contract closed down 27/32s at 90 20/32s. The September MOB spread was negative 384, compared with negative 388 on Tuesday.
Treasuries suffered more than municipals yesterday, with the longyield 7.54%
"Technically, we're in better shape than they are," the municipal market analyst said.
During his semiannual Humphrey-Hawkins testimony, Greenspan warned that inflation worries have already surfaced in the commodity and financial markets, including the foreign exchange market. "An increase in inflation would come at considerable cost," he said. He also warned of signs of wage pressures in the labor markets.
Yesterday's volatility, however, was not enough to derail New York City's $791 million general obligation bonds. Prudential Securities Inc. was the book-running senior manager on the offering, with Merrill Lynch & Co. as co-senior manager.
"In the face of a very volatile and deteriorating Treasury market, the city deal I think went very well," said Arthur Spector, managing director in charge of Prudential's public finance department.
Spector noted that the 30-year Treasury bond closed Tuesday at a yield of 7.46%, and was at roughly 7.56% yesterday when the city's deal was priced.
He said that meetings with institutional investors in Boston and New York, as well as conference calls, contributed to the deal's success. He cited "good" retail support and "solid'' institutional demand, which he interprets as a sign of institutional investors' confidence in the New York City credit's improvement.
"The institutional investor community is pleased with how the city is holding the line on the budget," he said.
While early estimates had called for a maximum yield of 6.50% in 2010, the preliminary pricing came at lower borrowing cost of 6.45%. At the repricing yields on some of the shortest maturities were lowered by 10 basis points, said Alan W. Murphy, senior vice president and manager of Prudential's municipal underwriting department.
Murphy noted some"slight repricing in the short end due to heavy retail demand," after which the deal was finalized. The issue was all sold, he said.
"The deal was received well," Murphy said. "We had excellent support from the syndicate co-managers." He cited strong retail demand out to seven or eight years, and "decent" institutional support from there on out.
The refunding helps the city balance its fiscal 1995 budget by providing $225 million in gap closing revenues. Although the issue offered some present value savings, for the most part it stretched out maturities to achieve budget relief- a move some fiscal watchdogs called imprudent.
Jerome Jacobs, a vice president at the Vanguard Group of Investment Companies, passed on the offering, although New York City paper makes up a sizable portion of the two funds he manages.
"We have a substantial commitment to the New York City credit and that commitment was purchased at much wider spreads than exist currently," Jacobs said.
He emphasized however that yesterday's pricing was fair. As he expected, New York's credit trend has improved since Vanguard made its purchases, Jacobs said.
Jacobs manages the Vanguard Municipal Bond Fund Inc.'s long term and high-yield funds. Those funds total roughly $2.75 billion, and New York City general obligation paper accounts for 3% to 4% of each one, he said.
The city refunding had provided an unexpected lift to a small segment of the massive U.S. treasury market, where prices fell on nearly all maturities based on comments made by Fed chairman Greenspan.
Dealers hoping to reinvest the escrow on the $791 million refunding on behalf of the city bid up an off-therun Treasury bill maturing on Aug. 4, 1994, helping to force down yields on this security by about 34 basis points, municipal market sources say. In contrast, yields on the current 1-year treasury bill rose nine basis points in the afternoon.
The refunding money must first be escrowed in Treasury bills before being placed in securities known as Slugs, or state and local government series. Slugs are a special kind of Treasury security issued to help state and local governments advance refund outstanding debt. Maturities and yields are tailored to meet the municipalities' requirements and federal arbitrage restrictions.
Several dealers speculated that the city should not have competitively bid out the refunding escrow. By bidding the escrow out, dealers competing for the one-year Treasury bill drove yields lower, and the city therefore received a lower interest rate on the reinvestment, they said.
But sources involved in the transaction disputed this, saying that any money potentially lost by the city on the treasury bill reinvestment will be made up when the treasuries mature in August, when the city places the money in Slugs. The Slugs could be engineered to make up the difference, market sources said.
In yesterday's dominant shortterm offering, California sold two series of 22-month revenue anticipation warrants totaling $4 billion as part, of a two-year cash-management plan.
The Series C credit-enhanced portion represented $3.9 billion of the offering, while Series D, sold without credit enhancement, totaled $100 million.
The state paid a net interest cost of 5.36%, state Treasurer Kathleen Brown told reporters after the sale, which was conducted in a Dutch auction format.
Asked if she felt the interest rate reflected an investor penalty prompted by last week's downgrade of the state's long-term obligations by three rating agencies, Brown replied that "borrowers are not banking on the state, but on banks that have given us their credit."
She said the interest cost California is paying is "the market rate done in a competitive bid environment."
Well-placed traders said the warrants were priced to yield 4.65% to the public.
The Series C Raws, which have an irrevocable standby warrant purchase agreement from a bank group, were won by seven separate bidding groups.
Morgan Stanley & Co. won $1.06 billion, followed by Merrill Lynch & Co., with $1 billion; Bank of America, $690 million; Goldman, Sachs, $500 million; Lehman Brothers, $400 million; Prudential Securities, $100 million; and, J.P. Morgan Securities, $150 million.
A J.P. Morgan Securities group took $100 million of Series D Raws, which are not credit-enhanced, with a NIC of 5.34%.
Brown, who characterized the offering as "the largest deficit financing in this state's history, and probably the largest in U.S. history," said the issuance would not have been necessary if California had better fiscal management.
When "you total it up," Brown said, the Raws' cost to taxpayers is $435 million. She said the figure includes nearly $31 million paid to the banks for credit support, and interest cost to the Raws' maturity of about $400 million. Other costs include cost of issuance.
"When I stop to think what that could buy for the middle-class taxpayers in California, it is an outrage," Brown said.
A total of 62 bids were received from 14 bidding groups, said state Controller Gray Davis, who conducted the sale. Davis said the fact that only one winning bid was received from Series D bidders "validates our strategy to seek bank guarantees of credit for Series C."
A rumor circulated yesterday that Goldman Sachs had submitted a true interest cost bid instead of a net interest cost bid and lost a good deal of bonds because of it. A source at Goldman called the rumor untrue.
The Goldman source said the bid form called for neither a TIC or an NIC, but rather for the total purchase price in dollars. Some firms converted that to an NIC, others to a TIC, which gave rise to the confusion, the source said.
Both series of Raws mature on April 25, 1996. The Series C Raws are rated SP-1 by Standard & Poor's, MIG-1 by Moody's, and Fl-plus by Fitch. The Series D unenhanced Raws were rated SP-2 by Standard & Poor's and MIG-3 by Moody's.
Over the next two weeks, California is issuing a record $7 billion in short-term obligations to finance its accumulated deficit and to meet cash flow needs for fiscal 1995.
The second part of the financing will be the July 27 negotiated sale of $3 billion of revenue anticipation notes, in two series, due June 28, 1995. Series A Rans will be fixed rate, and Series B, floating rate. The Rans are not credit enhanced.
Thomas C. Spalding Jr., vice president and manager of Nuveen Advisory Corp., was not a buyer of either the California or the New York offerings.
"We are going to pass on both," Spalding said. "We can't get our hands around the Cal deal. There's really nothing to compare it to."
The New York deal "outperformed," and came at levels too aggressive for Spalding's tastes. He would have like to have seen a top yield of 6.60%.
Nuveen runs about $2.5 billion in New York paper.