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California IOU’s soon to be DOA
As J.P. Morgan Chase has seemingly been the only rock in the financial storm, it is not surprising that the bank is now helping California, lending it $1.5 billion. The money will enable the state to stop issuing IOU’s a month earlier than planned (on Sept. 4). The loan is essentially a bridge until the state sells $10.5 billion in short-term notes next month. Here’s Reuters’ story.
The risk to JPMorgan is virtually nil: The loan will be repaid by late September, when the state plans to sell $10.5 billion of so-called revenue anticipation notes, or RANs — securities that will mature next spring. Individual investors are expected to flock to the RAN offering as a place to stash cash, because the notes should offer much more lucrative returns than money market funds and other short-term accounts paying next to nothing.
Some muni bond analysts expect the annualized interest yield on the RANs to be between 2% and 3%. For California residents, that interest would be exempt from state and federal income tax.
The loan is something of a about-face: J.P. Morgan was among the banks that refused to accept the state IOU’s after their first week.
California IOUs don’t look so hot anymore
Reuters is reporting that California lawmakers are close to inking a deal to close the $26.3 billion budget gap. You know what that means: no more IOUs. So don’t expect to see the IOUs popping up on a trading screen near you.
While a deal will bring the IOU drama to an end, it should create a new one in financial markets: a jump in California muni bonds since an agreement takes the prospect of default – no matter how unlikely it was in the first place – off the table.
Niche broker-dealer ready to trade IOUs
For those eager to buy or sell California IOUs, SecondMarket, a niche broker dealer that specializes in hard to trade assets, will launch its trading platform for the warrants on Wednesday.
But that doesn’t necessarily mean that trading will start tomorrow.
Buyers such as municipal debt portfolio managers, hedge funds and institutional investors are lining up for the service, according to SecondMarket spokesman Mark Murphy, but sellers not so much.
The constitutionality of California IOUs
Matt Yglesias questions here whether California is violating the constitution by issuing IOUs.
First you’d have to determine whether the warrants are debt or currency. States are prohibited from circulating their own version of the greenback.
Are IOUs securities?
That’s the question lots of folks are asking as they try to figure out how to potentially make money from the billions of dollars in IOUs being sent out by California this month.
If the Securities and Exchange Commission says yes, then two other regulators will be pulled in: the Municipal Securities Rulemaking Board, or MSRB, which would monitor the situation to make sure everyone is playing by the rules, and the Financial Industry Regulatory Authority, or FINRA, which would knock heads if there’s any wrongdoing.
Paying taxes with California IOUs?
From the AP via the Sacramento Bee, it looks like a lawmaker is proposing that California follow the Argentine model.
From AP:
State vendors and contractors could use their government-issued IOUs to pay state taxes, fees and liens under a bill approved by an Assembly committee.
Calling all banks honoring California IOUs
So far, I have Bank of America, Wells Fargo and Chase saying they will honor the California IOUs until Friday.
WSJ also puts Citi in the mix.
Here press releases from some others:
http://www.tcbk.com/documents/State-Issued-IOUs-Tri-Counties-Bank.pdf
https://www.cathaybank.com/a_SpecialNotice.asp
http://www.heritageoaksbank.com/
https://www.americanriverbank.com/policy_CA_registered_warrants
https://www.bankofthesierra.com/custom/bankofthesierra/pdf/CA-State_RegWarrants-070609.pdf
Fitch comes out swinging on California
Fitch Ratings is at it again. The credit rating firm cut California’s general obligation bonds by two notches to BBB, leaving the rating just two notches above junk. Fitch had already cut the state’s full faith and credit bonds one notch on June 25.
The junk threshold is an important one to keep in mind. If it’s breached, fund managers who can only invest in investment-grade credits would be forced to sell, causing valuations to tumble further. It would also turn up the pressure on legislators to sort out their differences and close the $26.3 billion budget gap.
Bank of America to accept California IOUs
At least one bank has said it will honor California’s IOUs, which the state’s controller will start sending out today. Bank of America said it will accept the warrants from its customers, at least through July 10.
The press release though doesn’t say whether the bank will charge customers an additional fee for the favor.
California’s IOUs may be difficult to cash in
With the California controller getting ready to send out the first batch of IOUs on Thursday, banks in the state are still trying to figure out if they want to buy the warrants from depositors. If they decide not to, get ready for crunch time and most likely the emergence of some kind of distressed debt market that will scoop up the IOUs – at a price – from those desperate for cash.
Just because the IOUs are sent to a specific person, business or local government doesn’t mean that they can’t be traded in or simply just traded. Whoever ends up holding them by their maturity date can redeem them with the state. And there’s certainly enough IOUs coming down the pipeline to make for a nice liquid market.
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