Municipal Bonds Thrive, Financing State, City Deficits

STATES and municipalities across the United States are facing mounting budget difficulties this year. But at least, in most cases, they are having no trouble financing their deficits. The demand for tax-free municipal bonds is up substantially. ``April was one of our very best months since January 1990, in terms of asset gains for state tax-free municipal bond funds,'' says Heidi Baxter, marketing manager for the tax-free funds of Fidelity Investments in Boston. The funds are benefiting, she says, from a ``combination of higher taxes, declining interest rates - which makes existing bonds more valuable, diversification, and the possibility of tax benefits.''

``We're getting a lot of very happy [muni-bond] shareholders these days,'' says Thomas Moles, a managing director for J. & W. Seligman & Co., an investment management firm. Despite recent highly publicized problems regarding municipal bonds in jurisdictions such as Colorado, California, and Philadelphia - with some bonds being put on credit watch - municipal bonds continue to attract investors.

Because of these problems, Mr. Moles notes, both individuals and portfolio managers of municipal bond funds are engaged in ``a flight to quality'' - they are looking for bonds given better gradings by the bond rating services. Moles, with more than $1.4 billion in tax-exempt securities under his management, is senior portfolio manager of both Seligman Select Municipal Fund and Seligman Tax-Exempt Fund Series. Seven of Seligman's tax-exempt funds were top fund performers in 1990, according to Lipper Anal ytical Services.

Bond experts note that the Tax Reform Act of 1986 not only simplified the US tax code, but left municipal bonds as one of the few remaining tax shelters for individuals. In 1984 the number of new tax-exempt issues slightly exceeded the $100 billion level for the first time. Throughout the late 1980s and into 1990 the value of new issues has hovered between $110 billion and $115 billion annually. This year the value of new issues is expected to grow 10 to 15 percent, reaching around $130 billion, says Mo les. Many states and municipalities are raising taxes to reduce deficits or service those new debts. Moles, not surprisingly, is a stalwart booster of municipals. Of course, these bonds are the raison d'^etre of the funds he is managing. Beyond that, the bonds, he says, represent the future of the nation. They provide funds for a much-needed revitalization of the physical infrastructure of cities, towns, and states around the US.

Municipal bonds are issued by state and local government agencies. They are often free of federal and state, and sometimes local, tax obligations. Municipal bond income can, however, be subject to the federal alternative minimum tax.

According to John Collins, a spokesman for the Investment Company Institute, a Washington-based trade group, the net asset value of municipal bond mutual funds has grown substantially in recent months.

THE total assets of national long-term municipal bond funds, with portfolios of bonds from many political jurisdictions, were $73.3 billion at the end of March, compared with $65.3 billion at the end of March 1990. Assets of single-state long-term bond funds stood at $52.4 billion in March, compared with $42.7 billion a year earlier. And assets of short-term municipal bond funds were $90.3 billion at the end of March, compared with $77.1 billion a year earlier.