Municipal bond experts wary after bankruptcy


NEW YORK -- Municipal bond experts are warily measuring the fallout from the Bridgeport, Conn., bankruptcy filing.

The evidence is far from conclusive. But it appears that the $840 billion municipal bond market, and the millions of investors who put their money into one of the few tax-exempt havens left in the United States, are taking this latest shock in stride.

It is also clear, however, that potentially explosive structural pressures are building in the local governments that underlie the municipal market.

The June 6 announcement that Bridgeport, Connecticut's largest city, was seeking state permission to file for protection under Chapter 9 of the U.S. Bankruptcy Code is the latest jolt to a market that has survived much in recent years.

Problems have ranged from the near-bankruptcy of New York City in the mid-1970s to the largest single-issue default in U.S. history (Washington Public Power Supply System's $2.25 billion default in 1983) to tax reform in 1986 that reduced the bonds' attractiveness to issuers and investors to Philadelphia's descent "junk bond" status.

Most experts don't expect Bridgeport's announcement to produce a rush to bankruptcy court by other financially strapped cities. The cost of this step for local governments that need continual and ready access to credit markets can be steep -- higher borrowing costs and the loss of investor confidence.

But Bridgeport has turned the spotlight on what C. Frazier Evans, senior economist for Boston-based Colonial Mutual Funds, calls "the cram-down effect of passing budget pressures from the federal to the state and then on to the local issuer."

"We've got some structural problems," said Richard Ciccarone, director of fixed-income research for Chicago-based Kemper Securities Group. "The Feds turned off the money." (Federal revenue-sharing and categorized grant programs were eliminated.) "At the same time, they mandated sewer and water programs. The last guy in line has no place to go."

The "last guy in line" is the municipality, caught by high fixed-labor costs, rising infrastructure and social program costs, a recessionary economy and angry taxpayers resisting higher taxes.

Default is the specter that scares bond investors. Significantly, Bridgeport hasn't defaulted on its loans and has pointedly said it intends to service its debt.

Since the Depression, municipal defaults have been relatively rare, but they are on the rise. Richard Lehmann, editor of Defaulted Bonds Newsletter in Miami Lakes, Fla., is projecting $4 billion in municipal bond defaults this year, up sharply from $1.8 billion in 1990 and $1 billion in 1989.

Higher taxes are being proposed by many local governments to shore up municipal finances. In sheer dollars, fiscal 1992 (beginning next week in most places) is likely to top previous records for state and local tax increases.

According to the National Association of State Budget Officers, states have proposed $6.6 billion in tax increases for fiscal 1992. That could easily double, said a spokeswoman for the Washington-based group, because California has proposed $7 billion in increases.

Higher state and local taxes also are increasing the demand for ** tax-exempt income from municipal bonds. And they are continuing to pour money into this sector, particularly bond mutual funds.

"Bridgeport has raised the discomfort level," said Patricia Deford, director of municipal credit research for Baltimore-based T. Rowe Price Associates Inc., "but it will not cause people to bail out of munis, because there is no other tax haven left."

At the end of April, investor demand for municipal-bond mutual funds was up more than 30 percent from a year earlier, according to the Investment Company Institute. As of April, municipal bond funds' assets had grown to nearly $130 billion, the institute reported.

It is easy to see why. One of John Nuveen & Co.'s open-end municipal bond funds, for example, is yielding 6.30 percent. For a comparable return in the taxable sector, investments would have to yield 8.75 percent for investors in the 28 percent income tax bracket or 9.13 percent for those in the 31 percent bracket.

Fund companies say they have seen little investor response to Bridgeport's problems. "We haven't seen any change in our business," said Jeffrey Kratz, director of investor relations for Nuveen.

"I don't think the market has overreacted in general," said Ms. Deford. "What Bridgeport is doing is causing people to step back and exercise more caution."

She added that the tremor has emphasized the "importance of professional management and thorough credit review. People are asking 'Where can I hide? Where are the safe spots? Which sectors are good?' "

Said Mr. Kratz: "The municipal market generally still is and always has been complex. But it offers tremendous opportunities. The problem areas are a small percentage of the total, but you need to have the time to do your homework and know the market."

"The reaction has not been as strong as I expected from the retail side," said Kemper's Mr. Ciccarone. There is more interest in insured municipal bonds. Municipal bond insurance was introduced 20 years ago, but most outstanding munis aren't insured. He estimates that about 27 percent of bonds issued in the first quarter were insured.

Beginning tomorrow, said Mr. Lehmann, bond insurance will be available to holders of existing uninsured munis. It will be offered by a unit of the Capital Guaranty Insurance Co. of San Francisco with the Bond Investors Association, the non-profit group that publishes Defaulted Bonds Newsletter.

Mr. Ciccarone sees the "potential for [other] financial shocks in the municipal market." Cities with chronic budget problems in regions with weak economies are particularly vulnerable.

So, barring default, for investors who are able and willing to hang on, their turn will come. For example, the busted Rust Belt bonds of some Midwestern cities are looking much better than they were coming out of the last recession -- and the glittering bonds of the Massachusetts miracle cities are, for now, out of favor.

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