The outlook for the municipal bond market is not pretty.

The Center on Budget and Policy Priorities, a Washington, D.C., nonpartisan research institute, was projecting state budget deficits of $200 billion for 2010. It estimates those state budgets deficits should shrink to $180 billion and $120 billion in 2011 and 2012, however, defaults in municipal securities are expected to rise in 2011 because federal economic assistance may decline, and state budget problems could hinder debt payments.

“Municipal revenue growth could be hindered for several years, according to a November 2010 survey by RBC Capital Markets in New York, the investment bank affiliate of Royal Bank of Canada. More than half of industry professionals surveyed say it could take at least five years before state and local government revenues return to pre-crisis levels. Driving concerns is the anticipated decline in the level of federal assistance for state and local governments over the next three years,” notes an article in Financial Advisor.

Don’t expect these economic conditions to brighten anytime soon. State tax revenues are down 12% since 2008. In 2010, 46 states struggled to balance fiscal year budgets, reports the Center on Budget and Policy Priorities.

The article quotes this warning from one investment advisor. “The fundamentals and creditworthiness of municipal and tax-exempt bonds is all over the map.” “That is why expert credit analysis is required when buying individual issues. Therefore, due diligence and credit analysis has never been more important.”