Municipal bond market resists Massachusetts downgrading

Municipal bonds may not be quite as solid as the Hope diamond, but most are sound investments. Some investors were shaken when Moody's Investors Service on March 27 suspended the credit ratings of Boston and 36 other Massachusetts cities and towns.

But thus far, experts say, the Moody's action has had no appreciable effect on the bond market as a whole. Nor is it expected to.

That's good news for the nation's other states and municipalities, since they often finance special projects and other activities through selling municipal bonds.

Sure to be affected, however, are the communities involved and quite possibly Massachusetts as a whole. But Moody's did not downgrade the Massachusetts state bonds.

Standard & Poor's Corporation, the other major bond-rating service, did not make any such suspensions. In December, however, after Bay State voters approved a law slashing property taxes, it lowered the Boston financial rating from "A-" (strong capacity to meet obligations) to "BBB" (adequate capacity to repay).

Moody's took similar action in June 1978 with some 250 California communities after the state's voters passeed so-called Proposition 13, the property tax rollback measure.

Standard & Poor's similarly acted in the wake of that vote and suspended temporarily the ratings of 248 California municipalities. This firm on at least three other occasions in recent years -- with New York City in 1975, Cleveland in 1978, and San Francisco last year -- withdrew its credit ratings.

Standard & Poor's, like Moody's, has restored ratings for most of the California cities and towns. And earlier this year S&P resumed rating New York City. But its current "BBB" credit label for the nation's largest city is a lower grade than the "A" rating New York held six years ago when the temporary suspension began. Moody's never suspended the New York rating, but it has remained at "B" level since April 1975, when the financial crisis hit there.

In theory, suspensions of ratings does not prevent governments involved from entering the bond market to raise funds. But such bonds are often difficult to sell. In fact, many institutional investors -- banks and insurance companies that often buy large blocks of such securities -- are frequently forbidden by their regulations from buying any bonds but those with top ratings.

Or course, no such restrictions confront individual investors. But uncertainty of the bond seller's ability to repay tends to make such offerings less attractive, usually resulting in higher interest rates.

In suspending its rating of Boston and three dozen other Bay State municipalities, Moody's spokesmen made it clear the move was temporary. Each case, the firm indicated, would be reviewed individually on July 1, when it may be clearer what the effect of the voter-mandated property tax cuts might be.

This reflects what appears to be a growing apprehension within some segments of the bond market as to the various communities' capacity to meet future, if not current, financial obligations.

"We simply don't know enough what the situation will be [under Massachusett's Proportion 2 1/2 property tax reduction] to support any rating," explains Timothy Crowell, a Moody's vice-president, adding that the state's current "A1" rating remains in place.

The rate suspension, though, may be having some adverse effect on the retailing of some of the $125 million in Massachusetts general-obligation bonds purchased for resale March 25 by a brokerage underwriting group headed by Bankers Trust. A significant portion of these 20-year securities, yielding 9.93 percent, remains unsold.

While there is little doubt that all will be sold eventually, the longer it takes the harder it might be for the commonwealth to reenter the bond market with reasonably favorable interest terms, until the financial stability of its local governments is clarified.

The situation in Massachusetts is quite different from that in California nearly three years ago, municipal bond specialists emphasize.

They point out that the California measure was a constitutional amendment which protected all outstanding debt from revenue-raising restrictions. In contrast, the Massachusetts Proposition 2 1/2 law does not make such previously incurred obligations immune from the tax rollback. This could affect the trading value of the state's securities, some observers suggest.

While thus far there is no clear signal as to what might be done toward restoring the ratings of Boston and the other affected Massachusetts municipalities, it is widely agreed within the financial community that Moody's intent is to make the governor and legislature "move tangiby and guickly."

Brokerage firm executives like Leon J. Karvelis, Jr., vice-president and manager of municipal research for Merrill Lynch, Pierce, Fenner & Smith Inc., note that municipal investors are trading cautiously.

Until the Massachusetts municipal ratings are restored, he and his colleagues anticipate that the bond market will remain leery of such investment opportunities.

Despite the financial problems of various local governments in recent years, investors continue to buy municipal bonds in large quantities. Last year a record $46.2 billion in such securities were sold, and although a levelling off appears to be in process, 1981 is expected to be close to that mark. A decade ago municipal bond volume was only $24.3 billion, less than half that of 1980.

Although interest rates tenad to be lower than corporate bonds, the municipal securities are generally free of risk, since, unlike businesses, governments rarely default.

Sales volume of municipal bonds is about twice that of corporate bonds. Companies can raise money through stock sales, bank loans, or in the short-term money markets as well.

A major advantage municipal bonds have over private corporate investments is their federal tax-free status.

Interest rates on government securities vary, depending on market conditions and the rating of the state or local government floating the bonds.

In the past, most municipal bonds ran for 20 years. While these securities can be and often are traded before their maturity, the seller can incur a loss or make a profit should interest rates go up or down, pushing the price of the outstanding bonds down or up.

Because of the increasing reluctance by some investors to tie up their money for 20 years in an inflationary period, 10-year bonds are becoming more prevalent in the market.

New York City, now back on what is generally viewed as more secure financial footing, reentered the bond market March 23 for the first time since April 1975. It sold some $75 million of securities at interest rates ranging from 8 percent for those maturing in 1982 to 11.5 percent for those running until the year 2001 .

The bond sale came less than three weeks after the city's six-year credit rating suspension by Standard & Poor's was ended.