By Darrell Preston

Oct. 1 (Bloomberg) — Rising borrowing costs are starting to pinch states, cities and towns across the country, forcing municipalities to cut back on everything from road improvements to maintenance on schools.

Louisiana postponed plans to sell $500 million of bonds this month, while in Chicago, school officials will have to decide which improvements will go forward after delaying a similar offering. Erie County, New York, has delayed dozens of capital projects.

Unprecedented turmoil in the credit markets is rippling across America, forcing cities and towns to scale back spending and tap reserves at a time when local budgets are getting squeezed because of a slowing economy. More than $12 billion in planned bond and note deals have been shelved since Lehman Brothers Holdings Inc.’s bankruptcy Sept. 15, twice what issuers usually sell in a week, based on data compiled by Bloomberg.

“Infrastructure projects can’t move forward,” said Whit Kling, director of the Louisiana State Bond Commission, which approves state borrowing. “Everybody is being hurt.”

The sting of higher rates is pinching borrowers from Jefferson County, Alabama, which may be forced into bankruptcy over a debt crisis, to top-rated borrowers like Mecklenburg County, North Carolina, home of Bank of America Corp., whose costs on bonds with interest reset weekly more than tripled to 7.48 percent from a month ago.

`Ugly Out There’

Costs are rising on both fixed- and floating-rate debt, with yields on 30-year AAA general obligation bonds climbing to a record 130 percent of those available on comparable-maturity U.S. government securities. Interest on variable-rate municipal debt with rates set weekly rose more than fourfold in two weeks to an average 7.95 percent, the highest on record, according to a Bloomberg short-term muni index.

“It’s ugly out there,” said Bob Cline, executive director of the Texas Bond Review Board, which oversees state bond issuance and saw the cost of short-term debt rise 3 percentage points to 8 percent. “There’s a terrible liquidity problem.”

September was the worst month for tax-exempt bonds in at least two decades, according to Merrill Lynch & Co.’s Municipal Master Index, which dropped 5.1 percent, the most since the index was created in 1989.

Sixty-four percent of cities are less able to meet their fiscal needs now than in 2007 because of rising operating costs, job losses and declining home values, according to a survey of 319 local finance officials released this month by the National League of Cities.

Refinancing Rush

For most of the year already, issuers have focused on refinancing floating-rate debt that jumped in cost when Wall Street banks abandoned the $330 billion auction-rate market in February. That contributed to the delay of an estimated $100 billion in issuance during 2008, equal to almost a quarter of last year’s record sales, as borrowing for new projects was put off, according to Municipal Market Advisors.

Louisiana still has auction-rate debt with rates as high as 14 percent. Having postponed the state’s bond sale, officials now will have to decide what projects to cut out of the state budget so it can pay for those it had expected to fund with proceeds from the sale.

“The bottom line is that they will have to be funded with some other funding source,” said Kling. “The only other source is the general fund.”

In Chicago, school officials will have to decide which projects will go forward after postponing a $500 million bond sale to next year. A school needing a boiler for its heating system before winter would probably get it, though other improvements such as wheel-chair ramps and paint touch-ups would be deferred, said Pedro Martinez, chief financial officer for Chicago Public Schools.

Unimaginable Market

“We’re making sure that we’re prioritizing our capital expenditures for anything that is urgent,” said Martinez. “These are unprecedented times for us. We never imagined the market could affect local government like us.”

The Metropolitan Washington Airports Authority last month deferred $2.2 billion in capital projects, including a new concourse and consolidated rental-car facility at Dulles International. The authority, which also runs Reagan National Airport, cited “current economic conditions, unprecedented increases in the cost of aviation fuel and their impact on the financial conditions of airlines” in bond documents.

This week, the authority postponed a $175 million bond offering to provide long-term financing for projects remaining in the airports’ construction plan through 2016. Instead, the airports turned to their commercial paper program to help provide interim cash for capital work until the bond deal can be completed in coming months, said Lynn Hampton, chief financial officer.

Erie County Crunch

The bond market freeze cost Erie County, New York, as much as $793,125 in extra interest and prevented the start of construction on dozens of capital projects.

The county paid the extra interest when it sold $75 million of revenue anticipation notes to Bank of America in a private placement after Roosevelt & Cross, a New York-based municipal bond firm, was unable to complete an offering Sept. 24 because it lacked the necessary financing, said Timothy Callan, a spokesman for county comptroller Mark Poloncarz.

“We needed the money to meet our end of September payroll and pay vendors,” Callan said. Bank of America’s 2.99 percent rate was almost twice as high as the 1.58 percent rate it quoted in August. “We weren’t able to get approval to sell then, and now we are hit by this market problem,” Callan said.

Projects Delayed

When Roosevelt & Cross was also unable to complete an $84.7 million issue of bond anticipation notes as planned, “it put our capital spending plans under a cloud,” Callan said. “We can’t continue advancing cash on capital projects without a bond sale,” he said.

The county has contracts requiring it to spend on improvements to Ralph Wilson Stadium, home to the Buffalo Bills football team, and has 60 other projects it has delayed, such as the $2.5 million reconstruction of Como Park Boulevard in the town of Cheektowaga.

The Salem County Special Services School District in New Jersey may face a shortage of cash after using $600,000 from its operating budget to begin renovation of a school. The district had expected to reimburse its budget using proceeds from an October sale of $6 million of bonds. That offering has been postponed, said Doug Wright, chief financial officer for the county, which is handling the bond issue.

Eagle Lake, Minnesota, population 2,159, postponed on Sept. 22 a $2.5 million sale of 20-year bonds intended to pay for a new city hall and public works building.

“We can pay our bills for now, but eventually we will have to sell the bonds,” said Brad Potter, city administrator for Eagle Lake, located about 70 miles (113 kilometers) southwest of Minneapolis. “If the market doesn’t improve then we might sell some temporary two- or three-year debt, and go back to the market later, when conditions are more attractive,” he said.

Bloomberg.com