Municipal Bond Buyers Asking Higher Returns

Afraid that financial troubles like Philadelphia’s may crop up elsewhere, municipal bond investors are beginning to demand higher returns for their risk.

Some analysts say yields have to get higher to make it worth investing in municipalities that face budget deficits, particularly in the slumping Northeast.

For cities and states that are already strapped, higher yields raise the cost of borrowing money.

Massachusetts on Thursday had to offer yields as high as 7.97% for a $1.3-billion package of revenue bonds. That was 1.5 percentage points higher than a Maryland offering earlier in the week.

The Massachusetts bonds were rated BBB by Standard & Poor’s Corp., while the Maryland issue got the highest rating, AAA. Massachusetts is running a budget deficit only two months into its fiscal year.

The so-called quality spread, which compares yields of lower-rated municipal bonds to the highest rated, has been narrow, but is beginning to widen, analysts say.

Yields on 30-year A-rated revenue bonds are running 45/100ths to 55/100ths of a percentage point higher than yields for AAA-rated general obligation bonds, according to Municipal Market Data Inc. Quality spreads are narrower for shorter-term issues.

Investors’ “concerns are legitimate in that quality spreads are still so narrow that they’re not getting paid for their credit risk,” said George Friedlander, municipal market analyst at Smith Barney, Upham & Co.

Philadelphia’s inability to sell about $375 million in short-term notes and officials’ predictions that the city will run out of cash around Dec. 1 have prompted municipal bond investors to focus on credit quality.

While Middle East developments continue to drive the market, concern has been growing over how a recession--which cuts into tax revenue--would affect the ability of cities and states to make debt payments.

“We have been concerned about the trend of a lot of state and local governments being asked to bear a larger share of entitlements and other programs required by the federal government, while at the same time revenue counted on to pay for the programs is not there,” said Neal Atterman, municipal research director at Kidder, Peabody & Co.

The stock of MBIA, a municipal bond insurer, has been hit hard by credit-quality worries. It sunk last week to around $25 from $37 the week before.

Many investors feel that MBIA is heavily exposed to Philadelphia’s debt and could suffer if Philadelphia defaults. However, the company said its exposure to Philadelphia debt is not excessive, and Standard & Poor’s affirmed MBIA’s AAA rating.

Standard & Poor’s and Moody’s Investors Service Inc. have lowered their ratings on Philadelphia’s general obligation bonds, which are backed only by the city’s faith and credit. S&P; rates the bonds CCC, Moody’s a B, giving them junk-bond status.

In the past, general obligation bonds were usually viewed as more secure than revenue bonds, which depend on user fees such as bridge tolls to make payments.

However, some analysts today disagree with that line of thinking. “People are still going to pay tolls in a recession,” said Nicole Anderes, head of municipal research at Roosevelt & Cross Inc., a New York-based investment firm focusing on Northeast municipalities.