Analysts are scrambling to understand the causes and repercussions after China's first sale of local government bond in years.

Liaoning province's municipal bond auction went undersubscribed on Friday.

As a result, it could raise only 400 million yuan ($64 million) of 10-year securities, less than the 550 million yuan target.

The notes were sold at a coupon of 3.99 percent, 15 percent higher than the yield on similar-maturity sovereign debt and is the biggest premium recorded so far. Other five-year bonds were also sold at a higher premium than similar bonds sold by other regions.

Liaoning is among the 33 provinces and cities that have issued low-yield municipal bonds to swap maturing high-cost debt. About 1.56 trillion yuan of bonds have been issued so far under the Ministry of Finance's 2 trillion yuan quota, with more quota expected to hit the market soon.

Liaoning officials are yet to give an official explanation, analysts and experts are debating whether this is an isolated case triggered by technical glitch, or a reflection of investors' growing concern over the broad municipal market, a factor that could affect subsequent auctions.

One possible explanation is investors' apprehension over Liaoning's deteriorating financial profile, something that could weaken its repayment capabilities.

Hit hard by the economic downturn, the rust-belt province that relies heavily on steel and petrochemical industries saw its fixed-asset investment growth fall by 13.3 percent in the first six months of this year. Its fiscal revenue during the same period fell by 23 percent from a year ago.

Special bonds are used to fund projects that generate revenue, while general securities are repaid using fiscal revenue. The fact that fiscal revenue will not be used to repay the special bonds intensified investors' fears, analysts said.

But some experts pointed out that Jilin and Heilongjiang, two other rust-belt provinces that are also facing economic headwinds, sold their municipal bonds without any hitches. All the nation's provinces and regions have been assigned the top AAA rating by credit ratings agencies given the strong credit support from the central government, despite their divergent financial profiles.

Some believe that other factors explained the banks' lukewarm attitude toward the municipal bonds. Li Qilin, a fixed-income analyst at the Minsheng Securities, said the current pricing of such bonds hardly factor in each region's standalone creditworthiness. Other non-market factors also play a key role.

One critical factor is that banks buy such bonds in return for local governments' fiscal deposit. Lenders' tepid response to Liaoning's debt might stem from the fact that they are barred from access to the province's fiscal deposit, Li said.

Shanghai Brilliance Credit Rating&Investors Service Co held a similar view. In a statement, the agency said Liaoning's local fiscal revenue is concentrated in one lender, and as such other banks see little hope of getting a share of the deposit pie even after they buy the bonds. About 18 banks and a security brokerage participated in Friday's auction.

Sale of the massive low-yielding bonds is not market-driven in the first place. After Jiangsu province delayed a bond issue in April due to insufficient demand from banks, the central bank and the Ministry of Finance had to add several incentives, such as allowing banks using such bonds as collateral to get central bank loans, to promote sales. Local banks buy these bonds mainly out of desire to cultivate strong ties with local governments.

Miscommunication between local governments and the banks before the closed-door auction could be another factor, analysts said.

Song Weijian, an analyst with China Bond Rating Co, said whatever the reasons are, the fact that non-market factors are affecting the sale is not sustainable. Hopefully such sales would be more market-oriented after this, he said.