Oct. 29 (Bloomberg) -- California sold almost $3.5 billion of tax-exempt bonds after raising prices and cutting yields as much as 0.15 percentage point from earlier estimates, in part because of a rebound in demand from individual investors.

The state offered its so-called economic recovery bonds in a refinancing deal prompted by a drop in sales tax revenue at yields ranging from 2.48 percent on four-year securities to 4.85 percent on debt due in 2022, data compiled by Bloomberg show. On Oct. 27, underwriters led by Barclays Plc and Citigroup Inc. were quoting estimated yields as high as 5 percent.

The largest tax-exempt borrower in the U.S. was able to pay lower yields than initially estimated, after a jump in bond payouts across the municipal market this month. Three weeks ago, California had to scale back another bond sale and agree to higher costs than preliminary quotes.

“The results of this sale show that no one should ever underestimate California’s strength as a bond issuer, or its record of producing great results for taxpayers,” Tom Dresslar, a spokesman for California State Treasurer Bill Lockyer, said in an e-mail to reporters today.

Individual, or retail, buyers placed orders equal to almost 72 percent of the deal the past two days before the state offered them to institutions such as mutual funds today. The treasurer’s office didn’t say whether this week’s total included orders exceeding bonds available at single maturities. Earlier this month, small investors sought 33 percent of the securities available to them when benchmark yields for states and localities were lower.

Short-Term Gains

Retail demand helped shorter-term state and local bonds to outperform long-term investments today. A daily survey by Municipal Market Advisors showed yields on two-year AAA bonds slipped one basis point to 1.15 percent while those on 30-year securities rose two basis points to 5.03 percent. A basis point is 0.01 percentage point.

The 10-year index compiled by the Concord, Massachusetts- based research firm was unchanged at 3.18 percent, where it has been since Oct. 21. The yield is up 22 basis points, or 0.22 percentage point, since Sept. 30.

The latest single piece of California’s deal this week, payable primarily from sales taxes and also backed by the state’s general pledge to repay bondholders, is $552.3 million of 5 percent bonds due in July 2018 priced to yield 4.4 percent.

The state on Oct. 8 sold 5 percent tax-exempt bonds due in October 2018 priced to yield 3.93 percent. They last traded yesterday at about 4.11 percent, according to Municipal Securities Rulemaking Board trade data.

Wider Spread

Buyers of the 2018 maturity early in the month got 104 basis points more in yield than top-rated debt tracked by Municipal Market Advisors. The spread on the latest issue is 32 basis points wider, 136 basis points.

The added yield premium was offered even though the economic recovery bonds carry higher credit ratings than other general obligation debt from the lowest-rated U.S. state because of the dedicated flow of cash from a quarter-cent sales tax.

California is refinancing bonds used to close budget deficits this decade to even out its repayment schedule after an 11 percent annual drop in sales-tax collections through June forced the state to tap a reserve account to make debt service.

The new issue got ratings of A+ from Standard & Poor’s, A1 from Moody’s Investors Service and A from Fitch Ratings. General obligation bonds are ranked one level lower, at A by S&P, and three grades lower, at Baa1 by Moody’s and BBB by Fitch.

Mandatory Tender

In today’s offering, $500 million of the bonds were sold with a yield of 3.375 percent, a final maturity of 2023 and a mandatory tender date of July 2014, when holders will have to sell back their debt for the rates to be adjusted.

Municipal bonds are headed toward their worst month in a year after local governments were forced to raise yields on new issues. The Municipal Master Index of Bank of America Corp.’s Merrill Lynch & Co. lost 2.25 percent in October through yesterday, the poorest performance since the record drop of 5.1 percent in September 2008.

California will be back in the market next week with a tax- exempt offering of general debt totaling almost $1.5 billion. A group of investment banks led by De La Rosa & Co., Stone & Youngberg LLC and Siebert Brandford Shank & Co. will market the debt to investors Nov. 3 and 4.

To contact the reporter on this story: Jeremy R. Cooke in New York at jcooke8@bloomberg.net.

Last Updated: October 29, 2009 17:15 EDT