Wednesday, February 13, 2008

Auction-Bond Failures Roil Munis, Pushing Rates Up

By Martin Z. Braun

Feb. 13 (Bloomberg) -- Bonds sold by U.S. municipal borrowers with rates set through periodic auctions failed to attract enough buyers as banks including Goldman Sachs Group Inc. and Citigroup Inc. that run the bidding won't commit their own capital to the debt.

Rates on $100 million of bonds sold by the Port Authority of New York and New Jersey, with bidding run by Goldman, soared to 20 percent yesterday from 4.3 percent a week ago, according to data compiled by Bloomberg. Presbyterian Healthcare in Albuquerque and New York state's Metropolitan Transportation Authority also experienced failures, officials said.

What began three weeks ago with too few bidders for auction-rate debt backed by relatively small entities, such as Georgetown University and Nevada Power, has widened in recent days to include large issues of state governments, such as New York state's Dormitory Authority. The auction failures provide new indication of Wall Street's unwillingness to commit capital amid $133 billion in credit losses and asset writedowns.

``It's the beginning of the end for the auction-rate market,'' said Matt Fabian, a senior analyst with Concord, Massachusetts-based Municipal Market Advisors. ``Banks have stopped supporting the market.''

Investor demand for the securities has declined on waning confidence in the credit strength of insurers backing the debt, and on reluctance by banks to submit bids and risk ending up with too many of the bonds. Local governments that have borrowed in the $300 billion auction-rate market confront the prospect of higher borrowing costs as economic slowing trims tax revenue.

Auction-Rate Bidding

Auction bonds have interest rates that are determined by bidding that typically occurs every seven, 28 or 35 days. When there aren't enough buyers, the auction fails and bondholders who wanted to sell are left holding the securities. Rates at failed auctions are set at a level spelled out in official statements issued at the initial bond sale.

Other borrowers paid higher rates, even if their auctions didn't fail. Wisconsin's 28-day auction yesterday of taxable bonds was set at a 10 percent rate, up from 4.75 percent for identical securities Feb. 7.

Frank Hoadley, Wisconsin's director of capital finance, said he had no advance warning from bankers about the jump in rates. ``We are making decisions'' about converting the auction bonds to different kinds of debt, he said.

Vermont Student Loans

Yesterday, $27.5 million of federally taxable student loan debt issued by Vermont's Student Assistance Corp. and insured by Ambac Financial Group Inc. reset at 18 percent, up from 5 percent as of Jan. 15. Ambac was the first bond insurer to lose its AAA credit rating.

Local governments are obliged to pay the high rates until either the auctions start attracting more buyers or they modify the bonds to some other kind of variable-rate debt or a fixed interest rate. Bankers and borrowers have been working on conversion plans for several weeks.

The 20 percent rate for the $100 million of Port Authority auction bonds will cost it $388,889 until the next weekly auction, up from $83,611 last week. Interest on the bonds is subject to federal income tax.

``We have seen widening spreads, reduced demand for certain auction-rate securities and failed auctions, including some auctions in which Citi acted as broker dealer,'' Danielle Romero-Apsilos, a spokeswoman at New York-based Citigroup, said in a statement.

Dormitory Authority

A Citibank-run auction for the New York state's Dormitory Authority failed yesterday, resulting in an interest rate of 6.26 percent, up from 3.12 percent a week earlier, according to Bloomberg data. Following the auction miss, the interest rate was set at twice one-month Libor, the London interbank offered rate for wholesale bank deposits, according to the official statement for the bonds.

Michael DuVally, a spokesman at New York-based Goldman, declined to comment.

The turmoil in the auction-rate market is the latest fallout in a credit squeeze that began with the subprime mortgage market collapse last year.

Bidding by dealers is essential to the smooth functioning of auction securities and banks are now wary of loading their balance sheets with the bonds, said Alex Roever, a JPMorgan Chase & Co. fixed income analyst.

`Tremendous Stress'

``This market has been under a tremendous amount of stress,'' Roever said. ``Without the dealers providing an active secondary bid, it's very hard for these transactions to clear.''

The soured auctions in recent weeks are the first since September, when about $6 billion of auction debt failed on investor concerns that bond insurers may lose their AAA ratings, Roever said in a Feb. 8 report. The latest wave began as recently as Jan. 22, when auctions run by Lehman Brothers Holdings Inc. for Georgetown University and Nevada Power failed.

Presbyterian Healthcare in Albuquerque, operator of seven hospitals throughout New Mexico, had rates on $38.7 million of debt reset at 12 percent after an unsuccessful auction run by Goldman yesterday. Bob Davis, Presbyterian Healthcare's vice president for treasury services, confirmed the failure, declining further comment.

Unsuccessful auctions have hurt companies that bought those variable-rate securities as short-term investments with excess cash, and are unable to sell their holdings. Bristol-Myers Squibb Co., the New York-based maker of the anti-clotting pill Plavix, announced on Jan. 31 a $275 million writedown of its holdings, which totaled $811 million at the end of 2007.

About a third of 449 companies polled in a survey last May for the Association for Finance Professionals said they permitted investment in auction-rate bonds.

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Lunch is for wimps

Lunch is for wimps
It's not a question of enough, pal. It's a zero sum game, somebody wins, somebody loses. Money itself isn't lost or made, it's simply transferred from one perception to another.