Many municipal issuers and issues are beginning to see the light at the end of a long tunnel filled with revenue shortfalls and increased service requirements, according to All-American Municipal Analysts.

But, a growing number of credits are likely to be an oncoming headlight of a speeding train destined for default.

It's appropriate at this critical juncture to separate municipal issues by credit type and region in answering this crucial question. For the "pain," as Claire Cohen of Fitch refers to the imbalances in revenues and expenditures, is moving through the municipal bond industry just as it moves through the U.S. economy.

Moreover, the implications differ for rating agencies, bond insurers, investors, and investment bankers.

Daylight For State GOs

Based on discussions with All-American Municipal Bond Analysts, daylight is dawning in the state GO bond sector.

Massachusetts obligations are again on solid footing and the political turmoil surrounding the ability and willingness to pay on the debts has settled. While everything isn't sunshine and roses, the outlook is brightening with the ability of the state to make better revenue forecasts and reduce spending.

Fitch's Ms. Cohen noted Massachusetts success in conquering its problems as a major reason why California's GO bonds have retained their higher ratings in the face of budget deficit gridlock. "California probably is perceived as having a more diverse and stronger economy than Massachusetts and the political problems were not as bad," Cohen reflected.

However, she believes "there are probably a few hidden deficits being rolled over and band-aids in budgets" that will cause problems for issues and issuers in the sector.

Few Stars Shine Among Urban Cities

During the past year, states have proven reluctant or unable to help their troubled cities.

The GO debt of cities such as Philadelphia, Washington, and even New York continues to face critical scrutiny. Sure, there is light at the end of the tunnel, but rising tax burdens and reduced city services are forcing homeowners and businesses to relocate in suburbs.

Consider the enormous buildup of business centers outside of Philadelphia, while prestigious office space downtown goes empty.

Additionally, the bailout of Philadelphia is based, in part, upon concessions by the city's unions, which seem loath to share the responsibility to remedy the problems.

But, just as the states have passed along burdens to the cities, so in turn are the cities sharing or passing through the pain to local municipalities.

Special District Opportunities

Thomas Kenny, director of municipal research for Franklin Group of Funds and first team All-American in the special district GO category, believes the sector offers the chance to crush homeruns with unrated issues.

"We were shown a deal, but turned it down for structural reasons," Mr. Kenny related. "After it was shopped around, another underwriter came to us with the transaction and we restructured it."

The underlying company responsible for tax payments in a Mello-Roos district received a significant upfront capitalization from its parent company (rated single-A) that would cover tax payment obligations. Also, the guarantee attached in a manner that wouldn't burn through for about eight years.

"We purchased the bonds with a yield of 8 3/4" and an effective underlying credit quality of a strong single-A, Mr. Kenny said.

He stressed the importance of performing independent and original research when examining credits in the sector. "We're out in front of the rating agencies," he said, "and we don't always agree with their analysis."

But, "the best time to be in the market is when no one else is willing to buy - as long as you do your homework."

Revenue Bonds Rock ~n Roll

In the municipal bond revenue sector, analysts were ready to rock ~n roll with individual credit qualities and a volume that doesn't seem to be willing to stop.

George Friedlander of Smith Barney, Harris Upham & Co., and co-first team All-American Portfolio Strategist had recommended revenue bonds based on a belief the sector typically is undervalued relative to GOs.

Gary Krellenstein, top vote getter in the 1992 balloting and first team All-American IDB/PCR analyst - the $100 billion sector - offers investors a great way to diversify.

Industrial development bonds and pollution control revenue bonds are conduit financings that defined by their structure, rather than credit quality.

Mr. Krellestein strongly recommends IDBs guaranteed by the National Rural Utilities Cooperative Finance Corp. (CFC)., which were upgraded this year but represent real value for investors.

Also, he recommends issues supported by Arizona Public Service Co., Philadelphia Electric Co. and Georgia Power Co. "Georgia Power has over $1 billion in PCRs and CFC has guaranteed in excess of $2.5 billion in bonds outstanding," he noted.

"There are plenty of bonds outstanding and even if rates do jump upward, we'll continue to see nearly $30 billion in issuance in the next three years because the outstanding bonds cannot be advance refunded and they were issued between 1982-1985 with 10-year call provisions," he said.

On the health care front, three time All-American Analyst Glenn Wagner expects that once the Presidential elections are over there will be a major regulatory reform movement, especially at the Federal level.

"Clearly something has to change nationally in terms of arresting runaway health care costs," he said, noting those costs now run about 14% of GNP.

Outlook for 1993

During 1993, expect to see greater interest in the general obligation bond sector, especially State issues. Analysts are predicting movements are afoot that will significantly impact credit quality for states and urban cities.

Regulation at the federal level will play an important role in determining winners and losers in the municipal bond arena.

The Public Utility Holding Company Act will streamline nuclear power development and greater use of natural gas as well as the greater development of independent power production and allow drilling on Federal properties, according to Alan Spen of Fitch and first team All-American Power Bond analyst.

In the health care sector, investors should look for large, suburban hospital with dominant marketshares to ride out any troubles.

In the high yield sector, Panhandle Eastern Corp.'s refunding of fixed rate securities in 1982 and variable rate debt in 1983 still offer investors a chance to gain in value, said Nancy Utterback of Kidder Peabody & Co.

Finally, the bond insurance companies should continue to enjoy good weather, but investors might want to check the quality of their protection - just in case, according to Mark Cohen of Fitch and first team All-American Bond Insurance analyst. "We want to help investors make sure they have the right umbrella if bad weather arrives in the bond insurance industry," Cohen said.

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