Threats of money problems continue to hang over U.S. local governments, but most cities and counties will still be able to pay their debts in the near future, Janney Capital Markets said in a special report on Wednesday.

In another encouraging sign, the municipal bond market, meanwhile has had little problem absorbing the increased new issue flow of the final quarter, it added.

Pennsylvania's capital of Harrisburg and Alabama's Jefferson County have recently moved to file for bankruptcy, but the filings were spurred by problems unique to those governments and do not herald a Municipal Meltdown, Janney said. It noted that local government credit quality remains strong, with high median credit ratings.

Although slight credit deterioration and rating downgrades are possible in the near term, medians will not descend far and bondholders will be paid, it said.

This week's $10.7 billion of new supply marks the biggest issuance week of 2011.

The demand side of the balance remains strong with municipal bond fund flows in positive territory for the eleventh week in a row, Janney added.

Janney expects reinvestment flows from maturing and redeemed bonds to pick up in December and into January after slowing this fall.

Still, Janney is keeping the cautious outlook on local governments that it assigned to the sector in 2009, citing lower revenues, rising pension and healthcare expenses, possible political resistance to fiscal decisions, and potential economic volatility from the European debt crisis and prospect of an economic recession in Europe.

Currently, the biggest question for both local and state governments is if a recent improvement in revenues will persist. Many places budgeted for the current fiscal year with expectations that their revenues would continue rising from recent historic lows. Now, six months in, some are beginning to worry their projections were too optimistic.

Those worries erupted in California on Wednesday with a state budget watchdog agency saying revenue has fallen so short that the state government must slash spending by $2 billion to keep its budget balanced.

The Legislative Analyst's Office also said the state will have to close a $13 billion budget gap for next fiscal year.

Governor Jerry Brown and fellow Democrats who control the legislature balanced the budget in June in part with the expectation of a $4 billion surge in revenue.

The Legislative Analysts Office, though, said only $300 million of that surge will materialize. Automatic spending cuts will kick in because of the shortage, and in coming years California will likely have to increase revenues or cut spending, the office said.

In the new-issue muni market on Wednesday, the biggest deal of the week came to market and priced for institutions a day early.

Retail buyers ordered $575 million of the New Jersey Transportation Trust Fund Authority's $1.315 billion of transportation system bonds in a pre-order period, which enabled the state to formally price the debt early, a spokesman for the Treasurer said on Wednesday.

We expected the deal to be completed (on Thursday), but the bonds went fast, Spokesman Andrew Pratt said by email.

The total interest cost was 4.845 percent, he added.

The bonds were priced by Morgan Stanley to yield from 0.79 percent in 2013 to 5.05 percent in 2042. The issue was rated A1 by Moody's Investors Service and A-plus by both Standard & Poor's and Fitch Ratings.

In secondary trading on Wednesday, prices of top-rated, tax-exempt munis ended unchanged on Municipal Market Data's benchmark triple-A scale. Yields on 10-year munis stayed at 2.33 percent, while 30-year yields were flat at 3.81 percent, according to MMD, a unit of Thomson Reuters.

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