UPDATE 2-Nevada, Georgetown Univ say muni auctions failed

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By Joan Gralla and Anastasija Johnson

NEW YORK Jan 30 (Reuters) - Washington, D.C.'s Georgetown University and a Nevada utility on Wednesday confirmed that a couple of their auction-rate municipal bonds had failed at auction, which experts said was believed to be the first time that this had ever happened.

Auction-rate debt is an instrument whose rates are reset periodically, and if an auction fails, the issuer must pay a higher penalty interest rate. An auction fails when no buyer can be found and the dealer does not take the paper back.

The confidence-rattling problems gripping bond insurers have sliced demand for the paper they guaranteed as well as other floating-rate securities. This has forced states, cities and towns around the nation to pay much higher rates than the 2-3 percent levels they had been paying.

Tax-free issuers have sold a total of $250 billion of muni auction-rate debt and many are now reviewing whether to switch to a different kind of floating rate debt, such as variable rate demand obligations, which can be more liquid.

Lehman Brothers LEH.N was the dealer for both of the debt issues whose auctions failed.

Other states and utilities that also used Lehman got hit with failed auctions of their muni floaters on Jan. 22, according to a market source. "It was a bad Tuesday," said the source, who requested anonymity.

Jan. 22 was the first day traders had a chance to react to a decision by Fitch Ratings to cut the credit rating for one of the biggest and most troubled bond insurers, Ambac Financial Group's insurer ABK.N, by two notches to "AA" from "AAA."

Fitch announced its decision on Friday, just before the start of the three-day U.S. Martin Luther King holiday.

A Lehman spokeswoman had no immediate comment.

Ambac insured the Nevada issue that failed at auction, according to William Rogers, the chief financial officer for the utility's holding company, which is called Sierra Pacific Resources.

Rogers explained that Nevada Power, one of his company's two utilities, was forced to pay the default interest rate of 6.75 percent after the auction failed for $115 million of tax-exempt debt sold on its behalf by a Nevada issuer.

However, the securities were auctioned successfully on Jan. 29, he added. While Rogers did not reveal the new rate, he said it was "considerably" less than the default interest rate.

The Nevada muni auction-rate program totals around $560 million and all of it is guaranteed by bond insurers, Rogers said. The guarantors include two other embattled bond insurers, MBIA Inc. (MBI.N) and FGIC Corp.

After Georgetown University's taxable auction-rate securities failed at auction, it too was hit with a stiff penalty rate, but a spokeswoman could not say whether the paper was still in the so-called failure mode.

Andrea Fereshteh, a Georgetown University spokeswoman, said only: "I can confirm that the January 22, 2008 taxable auction failed and the current interest rate is 6.6 percent."

Several insurers, including Ambac, MBIA and FGIC, are all struggling to raise capital because their subprime mortgage plays have turned into profit-eating monsters. Their potential losses are so staggering that credit agencies have told them they risk losing the "AAA" ratings their business requires.

Fitch on Wednesday cut FGIC's credit rating two notches to "AA."

FGIC is owned by a group including mortgage insurer PMI Group Inc PMI.N and private equity firms Blackstone Group (BX.N), Cypress Group and CIVC Partners LP.

(Reporting by Anastasija Johnson and Joan Gralla; Editing by Diane Craft)