Both sovereigns are facing economic woes. Both are facing huge budget gaps. But only one is facing runaway borrowing costs
The bond market is showing California is no Greece.
Debt issued by California, the world's eighth-largest economy, is outperforming Greece's bonds as funds including Cumberland Advisors say investors are betting the lowest-rated U.S. state's credit risk has been exaggerated. The cost to protect against California not paying its obligations is the lowest relative to Greece in at least 15 months, according to data compiled by Bloomberg.
Greece, with the European Union's largest budget deficit and an economy one-fifth the size of California's, is grappling with a debt crisis that's resulting in skyrocketing borrowing costs. The yield on the 10-year Greek bond rose to 7.16 percent on Jan. 28, the highest since October 1999, prompting European leaders to pledge aid to the nation. Even with an $18 billion budget gap expected over the next 15 months, California sold $3.4 billion in taxable debt last week at its lowest costs since November as overseas buyers purchased 30 percent of the securities.
“Investors are voting with their feet and they are coming to America,” said Peter Demirali, head of the fixed-income department at Cumberland Advisors in Vineland, New Jersey, which manages $1.4 billion. “They are saying that they will lend a billion dollars to California, no problem.”
California's constitution gives debt service priority on the $88 billion general fund, second only to education. The state has never missed a bond payment. Debt service as a ratio of the general fund is 6.7 percent, according to Treasurer Bill Lockyer.
“It's interesting that there is this Greece analogy around, which I think is far too apocalyptic for the facts,” Lockyer said March 30 in a Bloomberg Television interview. “As sovereign entities go, our debt is rather modest, so it seems to be an unfair comparison that creates doubts with investors.”
Elsewhere in credit markets, the extra yield investors demand to own corporate bonds rather than government debt fell 1 basis point yesterday to 149 basis points, or 1.49 percentage point, the lowest since November 2007, Bank of America Merrill Lynch's Global Broad Market Corporate Index shows.
Average yields rose to 4.015 percent, the highest since March 26. The securities returned 0.62 percent last month compared with 0.37 percent in February and 2.8 percent for the quarter through March 31, the data show.
The cost of borrowing in dollars between banks reached a new six-month high for a fifth day as the Federal Reserve prepared to end its debt-buying program designed to limit the fallout from the recession.
Benchmark indicators of corporate credit risk were little changed in Europe and Asia.
The Markit iTraxx Europe Index, which investors use to speculate on creditworthiness or to hedge against losses on 125 investment-grade companies, was unchanged at 78.5 basis points as of 10:48 a.m. in London, according to JPMorgan Chase & Co.
The Markit iTraxx Australia index rose 1 basis point to 86.5 basis points, according to Citigroup Inc., while the Markit iTraxx Asia index of 50 investment-grade borrowers outside Japan increased 1 basis point to 98, Royal Bank of Scotland Group Plc prices show. The Markit iTraxx Japan index also advanced 1 basis point to 115 in Tokyo, according to Morgan Stanley prices.
The Markit CDX North America Investment Grade Index Series 14 climbed 1.9 basis points to 88.2 basis points yesterday, CMA DataVision prices show.
Credit-default swaps pay the buyer face value if a borrower defaults in exchange for the underlying securities or the cash equivalent. A basis point equals $1,000 annually on a contract protecting $10 million of debt for five years. The indexes typically increase as investor confidence deteriorates and falls as it improves.
Traders in the derivatives are demanding 141 basis points more to protect against the bonds of Greece than they are for California's, the widest difference since at least June 2008, according to CMA. On average during that period, California traded 65 basis points wider than Greece.
The average yield on a seven-year taxable California bond sold March 25 declined 18 basis points to 5.44 percent as of March 30, Bloomberg data show. Yields on seven-year notes sold by the Greek government this week have risen to 6.4 percent, up from 6 percent when the debt was issued on March 29, according to Royal Bank of Scotland prices on Bloomberg.
California's $18.6 billion deficit is about 1 percent of the state's $1.8 trillion gross state product, while Greece's budget deficit equals 12.7 percent of its gross domestic product, the biggest in the euro region.
California's outstanding tax-supported debt, about $71 billion, is less than 4 percent of the state's gross domestic product. Greece's debt to GDP ratio is forecast to reach 120 percent in 2010, according to government figures.
Moody's Investors Service rates California's debt Baa1, its third-lowest level of investment grade, while Greece is ranked two steps higher at A2.
Speculation that investor concern may spread to other nations caused the euro to weaken this year and highlighted tensions between leaders of European nations as they negotiated a way to save Greece from default. Greece's quandary drew attention to a currency swap organized by Goldman Sachs Group Inc. in 2002 to hide the extent of its deficit and debt.
Prime Minister George Papandreou is battling to convince investors the nation is able to control its deficit. Greek government bonds were the worst-performing sovereign securities in the euro area in the first quarter, handing investors a 1.5 percent loss, according to Bloomberg/EFFAS indexes.
European leaders endorsed a Franco-German proposal for a mix of International Monetary Fund and bilateral loans at market interest rates to help Greece on March 25, providing the nation with a back-up in the event it fails to contain its debt.
Greece may pay about 13 billion euros more in interest over the lifetime of the debt it sells this year than it would have to had yields stayed at their pre-crisis levels relative to Germany's, according to Bloomberg calculations, using data provided by Credit Agricole Corporate and Investment Bank.
“Greece needs to get through its current funding and start growing at a decent rate so this large amount of debt doesn't snowball,” said Peter Chatwell, a fixed-income strategist at Credit Agricole CIB in London. “The market is currently reflecting disappointment that the seven-year deal didn't outperform.”
